Yesterday, the ECB published the account of its monetary policy meeting held at the beginning of September, shortly after the China-induced market sell-off. As a reminder, at that time the institution’s governor, Mario Draghi, acknowledged that the growth risks have become more skewed to the downside but other than that he maintained a broadly balanced tone. Nevertheless, since then the slowdown in emerging markets has gained in importance as the Federal Reserve abstained from rising rates notwithstanding domestic data remaining fairly supportive. As such, we have seen a build-up in expectations for additional Quantitative Easing in Europe with some analysts expecting the ECB to act as soon as this month.

With the next ECB meeting scheduled for 22nd October (to be held in Malta) and economic data disappointing of late markets will be eagerly speculating on the outcome and Draghi’s statement post meeting. Reading the summary of the points discussed last month by the ECB one would likely conclude that QE could (and should) be indeed extended although this might not come as soon as this month barring a worsening of financial conditions.

To make the discussion more specific, here are some highlights from the last meeting that I deem worth highlighting:

 The bank highlighted that the excess liquidity has been building steady which is to say that the amount of cash stored by European lenders with ECB has increased in one single month by EUR100billion to EUR499billion.

Meanwhile, the “loan dynamics remained weak overall” although many argue that the bank-depended European economy cannot grow sustainably without a strengthening in corporate loans growth. What is more, since then ECB has published enhanced statistics on loans to the euro area private sectors which basically resulted in downward revisions.

 In line with the first point above, the monetary council acknowledged that the subdued loan growth does not reflect a liquidity problem but “was seen in part to be still related to the ongoing adjustment of financial and non-financial sector balance sheets, particularly in some euro area countries in the wake of balance sheet recessions that were holding back more vigorous credit expansion by banks. In this context, reference was also made to the price-to-book ratios of listed financial companies, which remained low and had recently fallen again, notwithstanding the comprehensive assessment completed in 2014, the start of euro area-wide supervision by the SSM and the monetary policy measures in place. This suggested that the adjustment in the banking sector was far from complete, although more favourable price-to-book dynamics were visible when one considered only a sample of the largest euro area banks, which might benefit more from capital market activity.”

Personally I concur with such beliefs and, in my opinion, this means that QE will only support credit growth in the longer run and this mainly if it results in lower government yields as this would allow banks to book handsome gains on their portfolios (improving balance sheets) and result in a build-up in confidence. 

The problem of a renewed decline in market based long term inflation expectations is mentioned a few times. Of note, since then the five-year forward inflation linked swap rate five-years ahead (the measure mentioned by ECB itself) continued to decline. While, ECB briefly mentions that the raising correlation between oil and this inflation expectation measure means that it might have lost some of its significance, it also acknowledged that present measures of inflation “are not a very good predictor of future headline inflation”. 

Emerging markets were mentioned repeatedly as a downside source of risks even though the rout there has resulted in lower commodity prices “Challenges facing emerging market economies were clouding the global outlook and were unlikely to recede quickly, while lower oil prices were expected to support domestic demand in the euro area, but not to fully compensate for the impact of weaker global demand and a stronger euro exchange rate.”

The ECB staff also saw downside risks for investments and the possibility of limited follow through from monetary easing absent complementary structural reforms “It was observed that investment had remained very subdued in the wake of the crisis, with the current heightened uncertainty possibly weighing further on the investment outlook, beyond what was embodied in the September 2015 ECB staff projections, which showed investment picking up in 2015 and 2016, with a small downward revision in 2016. Attention was also drawn to the apparent disconnect between survey indicators and real economic performance in recent months, and the question was raised as to whether this could be due in part to insufficient progress with structural reforms needed to unlock growth and investment.”

“In their assessment of the risks surrounding the inflation outlook, there was also broad agreement that the risks were tilted to the downside, given lower commodity prices, a stronger euro exchange rate and a somewhat lower growth outlook.”

To conclude, I think the developments in the aftermath of the September meeting and ECB’s own discussion at that time show that it will be soon forced to announce additional stimulus. Given the ambivalent markets we have seen over the last few weeks it will probably defer such a decision this month but I remain of the opinion that ultimately the repeated downgrades in global growth and inflation will bring such measures. 

This article was issued by Raluca Filip, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.  

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