No Guarantee the ECB’s “Magic Wand” Will Work

CEIC WorldTrend Data Talk - January 13, 2015 In 2014, the European Central Bank (ECB) was very proactive in improving financial stability and boosting the Euro Area economy by launching a series of refinancing operations and asset purchase programmes. In September 2014, the ECB announced two new asset purchase programmes, which were initiated in the fourth quarter of 2014 and will last for at least two years. There are nevertheless questions concerning how the financial markets perceive these programmes and whether the ECB’s “magic wand” will work. There are indications that the new asset purchase programmes may have boosted the economy, from the evidence of sentiment indices. The Sentix Economic Indicator for the Euro Area shows 6-month expectations reaching a trough of -7.25 in October, to end a three-month declining trend since July 2014 (the Sentix Econimic Indicator is estimated in a range from -100: very bad or strongly deteriorating expectations, to 100: very good or strongly improving expectations). The indicator has been increasing since October and was restored to positive levels of 12.0 in December and 13.5 in January 2015. It is worth noting that the sudden jump in the Euro Area 6-month expectations indicator in December, which rose 14 points from the previous month, is the third largest monthly increase since the indicator was launched in July 2002. A stronger increase was observed only before the German elections in August 2005 (a 14.25 point increase), and when the ECB was about to launch its second long-term refinancing operation (LTRO) in February 2012 (a 17.25 point increase). Similar positive trends were observed from September to November in the business confidence and consumer confidence indicators; these are new statistics available in the Global Economic Monitor (GEM) under the WorldTrend database. The decreasing trend in business confidence saw it reach a low of -4.2% points in September, it then bounced upwards for two consecutive months, reaching -2.9% points in November before taking another dip and closing the year at -3.6% points. In October the consumer confidence net balance also levelled off from a downward trend (dropping from -4.0% points in May to -8.0 % points in September), but only to end up at -7.5% points in December 2014. Apart from sentiment indices, several market and other fundamental indicators also suggest that programmes similar to Quantitative Easing (QE) had a substantial effect on the economic recovery and initially alleviated the deflation threat. Whether the boosting impact can be sustained is another question. The gains in share prices on the stock market in November, when 9 out of the 10 MSCI Sector Indices for Europe edged up, provides some evidence of that lift. The only exception was the energy sector, which was dampened by the recent crash in oil prices. The December values, however, are not that promising, as only the information technology sector displayed a small increase, while all other indices decreased in value. Similarly, the deflation threat was held at bay too as the seasonally-adjusted harmonized consumer price index for the Euro Area shows, having increased by 0.09% points in October to 0.41%, from a 5-year low level of 0.31% in September. The Ifo’s World Economic Survey of the 6-month expectation of the EU inflation rate in the fourth quarter of 2014 registered a score of 6.0 out of 9, meaning the majority of the respondents believed that inflation would increase in the EU. Still, as it later transpired, with oil prices still falling sharply, deflation finally emerged in the consumer price index, which decreased in December by 0.2% year on year (according to the non-seasonally adjusted Eurostat estimate). The market reactions initially signalled that the asset purchase programmes performed a good job in restoring some confidence, but this renewed deflationary threat, amid weak growth prospects for certain euro zone countries, warns against complacency. The downward trend for sentiment and inflation from May to September, despite the announcement of the targeted long-term refinancing operations (TLTROs) in May, illustrates this, showing that the ECB’s measures may not necessarily be an “unquestionable success”, though there are lags involved so the effects may take time to bear fruit. The ECB can still lower interest rates and introduce other, unorthodox monetary measures to tackle the disinflation and deflation threats. However, the ECB’s policy rate, the main refinancing rate, is just 0.05% since the rate cut in September (the second reduction in 2014) and the close-to-zero rate makes it difficult for the ECB to further use rate cuts as a measure to tackle disinflation and the deflation threat, although negative rates have been trialed elsewhere and remain an option. The main impediment is the will on behalf of policymakers to carry out such stimulus, fearing the longer term consequences. Besides, a depreciating euro should assist economic recovery, and increasing actual liquidity at such low interest rates is not guaranteed. By Eric Ng - CEIC Analyst Discuss this post and many other topics in our LinkedIn Group (you must be a LinkedIn member to participate). Request a Free Trial Subscription. Back to Blog
13th January 2015 No Guarantee the ECB’s “Magic Wand” Will Work

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