The European Central Bank reduced interest rates and announced a series of other measures designed to boost bank lending Thursday as officials scramble to keep ultralow inflation from gaining traction. Photo: EPA
The European Central Bank went to town this week in an effort to head off the threat of dangerously low inflation. But the market reaction to its package of monetary easing measures suggest the ECB will have a tough time denting the persistently strong euro—a key contributor to sluggish price growth in the euro zone.
The euro dipped only briefly after the ECB unveiled its new policies, before rebounding hard. It is currently trading just above its level before the ECB meeting at $1.3665 to the dollar, albeit well below the high of almost $1.40 before the central bank last month hinted further easing was on the way.
At first glance, the measures introduced at Thursday’s meeting were good news for euro bears. Lower interest rates—including a negative rate on banks’ deposits at the ECB—make the currency look less attractive to investors. Some traders typically borrow in a low-interest-rate currency to lend in a higher-yielding one, profiting from the difference in a so-called carry trade.
But ultralow interest rates also further burnish the appeal of riskier assets within the euro zone, as investors flock to corners of asset markets that still offer returns. That is likely to attract inflows from international investors seeking to benefit from rising prices in areas such as riskier euro-zone debt, propping up the euro.
Indeed, bond markets in the euro zone’s periphery have continued to soar. Yields on Italian and Spanish debt touched all-time lows Friday. Yields and prices move in opposite directions.
“For us, [the ECB measures] reinforce the case for owning higher-yielding bits of the euro-zone fixed income market,” said Nick Gartside, chief investment officer for fixed income at J.P. Morgan Asset Management, which manages $1.65 trillion of assets.
Stocks have also benefited. The Stoxx Europe 600 traded at a fresh 6½ year high on Friday.
Here is how the central banks in four major advanced economies have moved two key levers of monetary policy in recent years, and how two important economic indicators have responded. View the interactive.
“Why is the euro not suffering? It is important that these measures are very supportive for European financial assets like equities and peripheral bonds. Hence, the ECB is actually attracting further portfolio investments into the euro zone,” said Stanislava Pravdová-Nielsen, an analyst at Danske Bank.
The ECB offered plenty besides rate cuts. But even here, it is doubtful whether any of the policies will trigger the portfolio outflows needed to weaken the euro.
A plan to make, for a start, up to €400 billion ($545 billion) in cheap loans available to banks later this year—providing they lend more to the private sector—comes at a time when euro-zone lenders are being encouraged to trim their balance sheets to pass upcoming ECB stress tests.
The ECB also said it was working on a preliminary plan to make direct purchases of bundles of private-sector loans—the first step toward a program of asset purchases known as quantitative easing. But the small size of the target markets makes it unlikely such a scheme could have a similar impact to the massive QE programs carried out by the U.S. Federal Reserve and the Bank of Japan.
Moreover, ECB President
hinted that Thursday’s rate cuts could be the last. “For all practical purposes, we have reached the lower bound,” he said.
That left nothing in the ECB package to make investors more negative on the currency, according to
a senior currency strategist at RBC Capital Markets.
“There was effectively no forward guidance on policy rates—indeed, [an] admission they are all but spent here—no mention of a larger-scale QE program, and much less jawboning on the currency than last news conference,” he said.
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