ON THURSDAY, the world’s equity markets got an unexpected, but thoroughly welcome present: a 25 basis points reduction in the European Central Bank’s (ECB) key lending rate. And the generous benefactor? None other than Mario Draghi, its newly installed head.
Analysts had not expected the move, not least because Draghi only assumed his new role a few days ago. With the legacy of Jean-Claude Trichet still fresh, many presumed Draghi would ease slowly into the job, reluctant to tarnish his predecessor’s good name with a rate cut this soon.
As the former head of the Italian Central Bank, Mario Draghi brings with him a briefcase full of skills and character traits that should serve him, and the ECB, well. Critics and admirers alike say he is a politically intuitive, pragmatic, calculating individual. In some ways, the classic central banker – conservative, thoughtful, cautious, deliberate, discreet – yet he’s also flexible and open-minded.
It is, perhaps, that open-mindedness which brought Friday’s interest rate cut. Economists and market participants have been demanding one for quite some time, condemning previous rate hikes as ill-timed and unnecessary. The numbers prove it. Throughout the Eurozone, even within the powerhouse economies of Germany and France, the data is bland at best, dismal at worst. Confidence and sentiment among households, businesses and investors polled has regularly struck new lows. Manufacturing is down, inflation is up, and the outlook is grim. And after the recent events in the Eurozone and Greece, markets needed to be buoyed.
There was surely no disagreement from anyone, anywhere, that something had to be done. And many believed that only the head of the ECB, in the form of Mario Draghi, would be able to make magic. The question was, did he believe it too?
The answer is yes, he believes; markets see that now. But what does that single, much needed, act signify? Does it represent a turning point for the ECB? Will they become more proactive? Will markets see more aggressive stimuli, perhaps even quantitative easing? Simply put, will the markets be getting a new ECB; one which could bring some stability to the system?
Of course, that stability comes with a caveat; it is at the expense of a significantly lower euro. The equity markets loved the interest rate cut. Indeed, the news of the rate cut pushed the European bourses higher, with investors hopeful that they could recoup some of the losses they incurred in the past few trading sessions. The currency markets, on the other hand, didn’t. The euro took a swift, hard hit against the dollar immediately after the announcement, losing nearly 100 pips before regaining some traction.
While Draghi did not make any promises or, indeed, hints as to future rate cuts, by virtue of the fact that he acted today, at a time when very few expected him to, speaks volumes as to the type of central banker we can expect – one who jumps into action when action is what’s desperately needed.
WHAT TO EXPECT?
Right now, it’s a little too early to make a decisive call as to whether the ECB is moving in a definitive direction of proactive, growth encouraging monetary policy. The extremely low bond yields in short-term US, German and UK debt instruments signal to me that there are large quantities of cash on the sidelines. Adding to that the extreme but legitimate scenario of a Greek financial collapse being priced into equities, perhaps more easing from the ECB, and a short squeeze could be around the corner.
With the Greek debacle looming, equities in either direction aren’t exactly a safe play, though commodities such as gold and oil could actually benefit from the easing of monetary conditions along the way. Hence, I continue to preserve my positive outlook for both precious metals and oil.
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