European Economic Update – 08 September 2014

The ECB rides again; cuts rates, announces asset purchases and pledges to do “whatever it takes”

The main event for the week from a monetary policy perspective was without doubt the surprise move from the ECB when it cut rates for the second time within the third quarter.

In detail, policy makers elected to cut the minimum bid rate by a further 10 basis points to 0.05%; the “final” rate cut according to Mario Draghi.

The Governing Council also agreed unanimously to further reduce the overnight refinancing rate by 10 basis points, bringing the rate at which the central bank would normally pay to financial institutions to park funds with it to -0.2%; meaning that the central bank now charges FI’s to deposit funds with it.

The move by European policy makers came after all forward looking indicators for eurozone inflation took a southward turn during August, when the benchmark CPI measure fell to 0.3%, leading “long term inflation expectations to become un-anchored”.

In addition to the reduction in rates, the Governing Council also agreed unanimously to begin purchasing asset backed securities in October as a means of providing further stimulus to the European economies.

While the bank has stopped short of full blown QE in its traditional form, which involves the purchase of sovereign liabilities, it has once again reiterated its commitment to the doing whatever is necessary to ensure long term price stability; which includes making use of more unconventional measures.   

As a result, continental indices outperformed many of their global counterparts over the week, while the euro plunged to its lowest level since the summer of 2013 when compared with many of the majors.

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Geopolitical risks

In addition to risks emanating from the threat to political union, the UK and many other economies are also exposed to rising levels of geopolitical risks.

With a diplomatic resolution to the Ukraine crisis yet to be found and given that NATO leaders have now begun to prepare plans for the deployment of military forces to eastern Europe; the current crisis in international relations between Russia and the west is becoming more and more difficult to avoid.

So far financial markets have continued to shrug off the developing crisis, barring the odd bout of news reactive volatility, although protracted period of time without resolution could threaten the prevailing sense of indifference.    

While a Moscow endorsed ceasefire has, at the time of writing, led to a break in the conflict; it is not clear that this will be enough for the international community to stem the flow of sanctions against Russia.

Equally it is also unclear what the reaction from Moscow will be to a further round of sanctions in the face of the ceasefire, or to the positioning of western military supplies in eastern Europe.

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The takeaway

While we remain optimistic in our outlook for European equities on the whole, risks facing investors have increased substantially throughout recent quarters and this is becoming increasingly more relevant in our evaluation of the continental investment landscape.

Consequently, we will continue to assess both new opportunity, as well as our existing portfolio holdings, with increased levels of caution throughout the weeks and months ahead.

EU Indices: DAX (Black), CAC40 (Blue), IBEX 35 (Red)

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Euro Exchange Rates: EUR/USD (Black), EUR/JPY (Blue), EUR/GBP (Red)

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IMPORTANT:
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