David Morris

LAST Thursday brought rate cuts from the European Central Bank (ECB), the People’s Bank of China (PBOC), and the Danish and Kenyan central banks. On top of this, the Bank of England’s Monetary Policy Committee (MPC) raised its asset purchase facility by a further £50bn. Whether coordinated or not, these actions represented substantial monetary easing.

However, the overall market reaction was muted, on disappointment that the ECB and MPC hadn’t gone further. Some analysts had factored in a 50 basis point cut in the ECB’s minimum bid rate (rather than 25) and an increase of £75bn to the Bank of England’s gilt purchasing programme. Negative sentiment increased as ECB President Mario Draghi made no mention during his statement of the likelihood of additional unconventional monetary stimulus. So it was only the PBOC’s unexpected cuts to its lending and deposit rates that had a positive, albeit brief, effect on “risk assets”. But traders then began to question the motives for China’s surprise move. After all, this was the second PBOC cut in a month, and this week brings a raft of important Chinese data releases, culminating in second quarter GDP on Friday. Investors began to speculate that the easing was a pre-emptive measure, ahead of evidence that may show that Chinese economic growth is slowing more sharply than previously anticipated.

Equities, precious metals and oil were among the major markets which rallied strongly at the beginning of last week. This followed what, on the face of it, looked like a successful EU summit. However, markets began to head lower from Wednesday, as the US dollar rallied. The euro has suffered particularly badly; with the euro-dollar now well below pre-summit levels. Spanish 10-year bond yields have once again topped 7 per cent – an indication of the stresses that still exist despite the EU’s progress. German Chancellor Angela Merkel appeared to make concessions to her troubled Eurozone neighbours. But when considered in greater depth, these concessions are not the game changers that they first appeared to be. And the European Financial Stability Facility and European Stability Mechanism (the two European bailout packages) are not credible backstops if pressures continue to mount on Spain and Italy – let alone France.

Meanwhile, Friday’s US non-farm payroll data provided yet more evidence that the US economy is struggling. Coming in at 80,000 (against a whisper number of 120,000), the data logged its fourth successive big miss. This latest release carried additional significance, as it was the last payroll report before the next Federal Open Market Committee (FOMC) meeting. Yet, as weak as it was, the feeling is that Friday’s number just wasn’t bad enough to warrant the announcement of further quantitative easing (QE) when the FOMC meets on 31 July and 1 August. There is a worry that it will take more than weak data for the Fed to act and, without additional liquidity measures, risk assets look set to struggle this summer. Ironically, it could be that the Fed will need to see a significant downside correction in equities (maybe 20 or 30 per cent) before they will feel the need to intervene further. After all, QE remains highly controversial, and is not without significant risk – both economic and political.

Overall, it is now painfully apparent that, more than three years on from the financial crisis, the global economy remains in a parlous state. Debt remains at crippling levels and is helping to choke off nascent growth. De-leveraging is having a deflationary effect, which central banks are looking to offset. Consequently, the only action that gets a positive response from markets is a full-blown unsterilised intervention – in other words, money printing. However, the positive effects of such interventions on asset prices are having a shorter and shorter half-life. In addition, all QE seems to do is ensure that insolvent banks in the developed world get propped up, rather than allowed to fail. Full-blown Japanese-style zombification now seems the most likely, and sadly the best outcome that any of us can hope.