Running out of grenades isn’t a bad thing

The tentative conclusion most commentators have drawn from the European Central Bank (ECB) press conference overnight is that Draghi has run out of easing ammunition, and that this is a bad thing.

ECB
Source: Bloomberg

What he delivered:

  • Deposit rate to -40 basis points (bps) cutting by a further 10bps
  • Refinancing rate to 0%, a 5bp cut
  • Margin lending rate to 0.25%, a 5bp cut
  • Quantitative easing expanded by €20 billion a month to €80 billion
  • New series of longer-term refinancing operations

This delivers on expectations, (and a little more with the additional targeted longer-term refinancing operations) however the issues came with this line during the press conference:

‘Rates will stay low, very low for a long period of time and well past the horizon of our purchases. From today's perspective and taking into account the support of our measures to growth and inflation, we don't anticipate that it will be necessary to reduce rates further.’

Which may explain why the Street is using this line to really describe where the ECB is at in its monetary policy cycle:

‘If you fire a bazooka all you are left with is an empty tube.’

Interesting conclusion as these comments are in the main from currency commentators who had to watch EUR/USD move through a 3+% range as the conference progressed.

This will have made a lot of people very unhappy and will have most concluding Draghi has disappointed.

However, as an index and equities strategist, I see Draghi’s empty grenade box as a good thing. I would argue monetary policy is starting to become counterproductive. What I hear and see is a positive for European equities.

European banks have long been calling on negative rates to either be scrapped or mitigated as negative rates impact earnings and the banks’ ability to operate credit books.

But, with today’s announcements, the conclusion is ultimately there are benefits for the bigger banks.

Those banks that are wholesale funded and geographically diversified will be cushioned from the deposit rate and the general uptake of corporate debt as a secondary effect of monetary policy are a net positive for banks.

Core European nations with exposure to manufacturing are, in the long term, also likely to be positively impacted as the shear amount of credit in Europe flows into consumer spending.

BMW just announced a record profit and the ECB actions will make high-end manufacturing all the more attractive. High-end manufacturing is also benefiting from lower primary costs and despite the last three to four weeks of rises in industrial metals and oil, prime costs are down – an added benefit to core manufacturing European nations.

These two stats from previous ECB meetings still hold true:

  • In the past 15 ECB meetings, only two have seen the equity markets down in the preceding month.
  • Four of the past 15 ECB meeting saw over 6% rises in equity markets the preceding month – not surprising since these four months were after the big stimulus releases – which makes tonight very interesting.

I can’t see what happened last night as not being a net positive for European equities. The EUR curve ball has certainly clouded the very short term outlook, but Draghi mainly met expectations and has publically stated that rates are now going to be rooted to these level for years. Equities will ultimately win out with policy that accommodative.

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