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ECB Stimulus Signals Deep Financial Repression 

 

The Upshot 

6/9/2014 

The European Central Bank’s latest actions to fight falling inflation and slow growth reveal how much financial repression is dominating global capital markets, which should drive prices of risk assets higher, writes Kristina Hooper.
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Kristina Hooper is the US investment strategist and head of US Capital Markets Research & Strategy for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.

Mario Draghi is doing “whatever it takes” to revive Europe’s economy, but that means financial repression is here to stay.

Last Thursday, the European Central Bank announced an unprecedented—but widely anticipated—set of actions in its fight against deflation by injecting monetary stimulus into the euro-zone economy and pushing its target interest rate below zero.

ECB Revised Inflation Forecast chart
In a press conference, ECB President Mario Draghi said that interest rates will remain at this low level for an extended period of time, but assured that the ECB will not push rates lower from here. However, he’s not ruling out the use of additional measures to jumpstart growth, including unconventional policy tools.

As part of last week’s decision, the ECB laid out five key actions, some of which resemble actions we’ve seen from the Federal Reserve. It’s important to note that the exclusion of housing loans in the targeted long-term refinancing operations (TLTROs), which is a way that the ECB can provide financing to euro-zone banks, reflects the ECB’s desire to stimulate the real economy only—but not follow in the Fed’s footsteps by inflating asset prices (that’s why mortgage loans are excluded) or government bonds. These parameters are concessions to the more hawkish faction within the ECB’s governing council, which is concerned about overheating local real estate markets in Germany.

In short, these measures are designed to accomplish three things: to ease monetary conditions, to improve the real economy and to boost liquidity and lending. Of course this new stimulus package will also push the euro zone into a tighter embrace with financial repression.

What’s Next for the ECB?

Allianz Global Investors’ Economics & Strategy Group believes that the ECB has exceeded expectations by delivering on all of the options that it had previously discussed. If necessary, the next major step would likely be a large-scale bond-purchasing program, which is still a possibility if inflation rates decrease from here or stay near 0%. We think it’s unlikely that the ECB will be able to boost inflation with its current moves given that the ECB can’t influence weak credit demand, and the credit channel only indirectly and slowly impacts inflation rates.

Ultimately, the ECB’s latest stimulus package reminds us that financial repression is the dominant theme in capital markets globally. And it’s not going anywhere any time soon.”
So what does this extraordinary monetary policy environment mean for investors? Ultimately, the ECB’s latest stimulus package reminds us that financial repression is the dominant theme in capital markets globally. And it’s not going anywhere any time soon. Meanwhile, last week’s US employment report did little to alter the Fed’s highly accommodative stance.

In this environment, risk assets should perform well. Specifically, we expect moderate support for euro-zone risk assets, including periphery bonds, and slightly higher yields for German bonds in the near term. We also expect US stocks to move slightly higher, despite valuation concerns.

Still, longer-term effects on asset markets depend on whether central bank policies in both the euro zone and the United States can accelerate economic growth.


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The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

 
Past performance of the markets is no guarantee of future results. This is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies and opportunities.


A Word About Risk
: Equities have tended to be volatile, involve risk to principal and, unlike bonds, do not offer a fixed rate of return. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets.
 

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