26 August 2014

ECB’s big bazooka – will it or won’t it?

Will the European Central Bank be provoked by economic pressures into launching quantitative easing?

​​​​​​​Faced with a weakening economy and serious deflationary risks, the European Central Bank (ECB) is on the verge of unleashing its big bazooka: quantitative easing (QE).

With stagnation in core economies combined with falling inflation rates, the ECB has to fight off Japanese-style deflation gripping the Eurozone. The ‘Draghi Put’, which effectively put a price floor on EU members’ sovereign debt, worked in 2012 but now more proactive monetary policy - and stimulus – are required.

What does this mean for traders?

  • Financial markets have been badgering the ECB to implement aggressive stimulus measures such as QE for some time. Sluggish growth, economic imbalances, deflation risk and a strong euro (EUR), all prove to be a persistent headache for markets.
  • Will we see QE unveiled by the ECB on September 4? Politically, nations are on opposing ends with Germany reluctant to engage in QE-style mechanics while France endorses it. At the same time, governments in the euro area have failed to implement much needed structural reforms to feel the effects of the ECB’s stimulus responses thus far, yet alone the effects of future QE measures.
  • For traders, ECB teetering and Eurozone political dithering could mean increased bouts of uncertainty, prompting spikes in volatility and a stubbornly high EUR currency which might not comfortably depreciate until the ECB takes action.

What are the likely positive effects of QE?

While the impact of QE will vary from economy to economy, these THREE likely outcomes could be assumed:

  1. Restoration of ECB’s credibility as QE will signal the central bank is committed to the Eurozone economy at all costs – confirming Draghi’s “whatever it takes” speech back in 2012
  2. QE increases liquidity. This will mean increased flows into capital markets, with emerging markets likely to benefit from increased investment
  3. A weaker EUR as QE cheapens currencies, providing a better market for European exports.

Conclusion:

Since the Eurozone crisis began in 2010, the ECB’s actions have been reactive rather than active. Its reluctance to implement aggressive measures has stubbed out the Eurozone’s growth potential. With the spectre of deflation looming large, the ECB may have to swallow its pride and fire that QE bazooka.

All eyes are now fixed on the September 4th policy meeting.

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The value of your investments can go down as well as up.
Losses can exceed deposits on margin products. Please ensure you understand the risks.