Markets reacting positively this afternoon to the latest press conference by ECB governor Mario Draghi. European equity markets are driving ahead and taking the US and, to a lesser extent, the UK seemingly with them; the Euro has weakened by 1.6% against sterling so far and slightly more against the dollar. Basically the message from Draghi has been interpreted as very doveish; although no changes were made today (but Draghi said some members had wanted change), the ECB is seen as likely to become even more accommodative at its December meeting, with all monetary policy options on the table. So reducing the deposit rate-negative interest rates may be coming-and more and extended QE are being predicted.
Whether this sunny picture will last when attention turns back to the Federal Reserve is another matter. It may be that markets are celebrating a bit of clarity at last – even if it is clarity that the outlook has worsened so more needs to be done – as opposed to the will she/wont she (raise interest rates) position of Janet Yellen at the Fed. To be fair Yellen has to deal with a much more mixed picture, where her domestic economy has been performing pretty strongly, but still is not immune from external forces – and particularly the slowdown in China.
Draghi has a more unambiguously slow economy to attempt to galvanise and may have been helped in that even the Germans are beginning to feel a bit of a pinch as their exports to emerging markets come under pressure. There is a danger, of course, that this becomes a battle of exchange rates, even if this will never be acknowledged. The weakening of the euro means that much of the gain in equity markets (and also fixed income markets with the German Bund price spiking upwards) will be lost to unhedged sterling investors. The other side of euro weakness is of course dollar strength; this in turn may mean that the Fed is less likely to raise rates in December and so the saga could go on.
Draghi’s main point seemed to be that while core eurozone inflation was stable at 0.9%, the potential downside risk to the medium to long term inflation expectations (ie. the risk of outright prolonged deflation) had grown. The factors behind this were: a still high output gap (the difference between the economy’s potential and what it was actually producing), a possible further fall in oil prices (although of course these could go the other way), the fact that the euro had strengthened by 8% since the last ECB meeting and the strong correlation between the headline inflation rate and long term inflationary expectations.
As ever the ECB is governed by its mandate which is to deliver inflation of close to but below 2% over the medium to long term. If medium to long term inflationary expectations are falling from their already low levels, then the governor argued that there was an onus on the ECB to act.
In answering questions at the press conference, Draghi made some interesting observations. He was asked about the effect of China’s slowdown on the eurozone: he identified four channels of possible influence:
- Direct – only 6% of exports overall went to China, although for Germany it was 10%.
- Indirect – the extent to which the Chinese economy acts on oil and commodity prices.
- Financial – ie. the extent which stockmarket losses in China affect eurozone citizens – which he described as not very significant.
- Confidence. Here he said that the Chinese position had not affected confidence in the euro area.
Quite a nice summary of the way external factors can impact in the modern global economy.
Draghi was also asked about the VW emissions scandal and the migrant crisis. In both cases he said it was too early to say anything on the likely economic impact.
Another confident performance overall from the ECB governor. The Euro Stoxx 50 is up nearly 2.5% at the time of writing.