EU Economic Update – 24 November 2014


Mario Draghi preps Germans for QE, continental markets rally

Developed markets continued to advance last week as economic data emerging from the US continued to point toward a strengthening recovery, while Mario Draghi at the European Central Bank delivered his second career defining performance when he signalled to the continent’s bankers in Frankfurt that Quantitative Easing is on the way.

In detail, a steady flow of economic data from the US kept markets supported for much of the week, including better home sales, manufacturing and inflation numbers; while an absence of bad news from most other regions also contributed to the positive performance.

Most significantly for US economy watchers, Core CPI rose at an annualised pace of 1.8% according to data released for October, closing the gap between the current pace of price pressures and the Federal Reserve’s 2% target. This delivered a positive boost to investor expectations relating to both wages and overall growth.

Despite a strong showing from US economic numbers, the headline act for the week was performed without doubt by Mario Draghi, who after regurgitating much of the various texts from past non-event speeches used his address to the “European Banking Congress” in Frankfurt as his opportunity to inform the Germans that QE is firmly on the table as an option.

“We will do what we must to raise inflation and inflation expectations as fast as possible, as our price stability mandate requires of us. If on its current trajectory our policy is not effective enough to achieve this, or further risks to the inflation outlook materialise, we would step up the pressure and broaden even more the channels through which we intervene, by altering accordingly the size, pace and composition of our purchases,” – M Draghi, November 2014

The governor’s speech prompted the euro to fall sharply against all major currencies, while delivering an instant shot into the arm of continental equity markets; many of which gained upwards of 2.5% on the day.

Although the governor didn’t go so far as to give a specific indication of when further action could be expected, it stands to reason that should the euro-zone rate of inflation fall further below the current 0.4% next month, then the bank could act as soon as December or January.

In addition to the policy maker action in Europe, continental markets also received another boost on Friday when the People’s Bank of China announced a surprise cut to benchmark interest rates, as concern among officials over both growth and inflation reached a head.

While the growth outlook for continental economies remains sub-par the reaction of markets to Friday’s events appears to indicate that, for the time being at least, central bank actions on inflation across the UK, euro-zone, Japan and China should continue to offer an incentive for investors to remain bullish on equity markets.


Looking at the data

Economic data releases for the euro zone were few and far between in terms of volume last week although, those that were due did little to change the prevailing view that the continental economy is stagnating.

French and German Flash Manufacturing PMI’s for November underperformed against estimates, with the French index falling further into contraction territory and the German index falling to the breakeven line of 50.0.

French and German Services PMI’s also underperformed with the German index falling from 54.4 to 52.1 and the French survey rising by a fraction, but remaining firmly within contraction territory.

Both sets of data were released just 24 hours before Mario Draghi’s appearance in Frankfurt on Friday, and could be the catalyst which drove the change in tone following his much blander speech to the economic and monetary affairs committee earlier in the week.

On a brighter note, the German ZEW economic sentiment index did indicate that pessimism among German businesses may have bottomed when the official reading for the survey came in at 11.5 VS expectations for a much lower figure of 0.9.  

The ZEW survey was followed this Monday morning by the German IFO Business Climate survey which also indicated an improvement in sentiment during the month of November. The survey index number came in at 104.7 vs official projections for a reading of 103.0.

All in all, the previous week’s data continues to suggest that the economic weakness which has decimated the periphery during recent years has now reached the very core of Europe.

German growth expectations have been revised downward persistently throughout the year so that 2014 expansion is now likely to be little more than 0.5%.

Furthermore, France continues to struggle with a lacklustre economy while pressure from Brussels over fiscal discipline could see forced austerity measures ensure that the nation remains, at best, close to recession throughout much of 2015.

One good thing to have emerged from this for investors is that Mario Draghi, the ECB President, now faces another slow motion car crash which has forced another belated “all it takes” moment.

It now appears almost certain that the ECB will be forced to announce a QE program of its own at some point between now and the close of Q1 2015. First impressions, based upon Friday’s reaction, suggest that this could be positive for equity markets despite the doubts of a growing number of analysts.

The important question from here are whether or not the ECB’s eventual effort will be seen as credible by the markets, so; does it stand a chance of easing the continent’s economic pain and promoting growth?

An furthe secondary question, but equally as important in the longer term; what will the political fall out be? With the German sphere of Europe firmly opposed to any form of money printing or bond buying, will a broad QE program at the ECB prompt a new wave of euro-skepticism, although this time from the pro-union, pro-ever increasing integration German public?

DAX (Black), CAC40 (Red), IBEX 35 (Blue)




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