The ECB Adds New Stimulus: An Exercise in Futility?


 

The ECB surprised markets last Thursday with the renewed dovish tone of the announcement.   ECB President Mario Draghi stated that interest rates would remain at record lows at least until December, as he slashed growth expectations for the single currency area, and announced new loans to euro zone banks.  Perhaps most disconcerting were Draghi’s comments in the press conference, where he said:

 

“We are aware that our decisions (new stimulus) certainly increase the resiliency of the euro zone economy, but actually can they address these factors that are weighing on the euro zone economy in the rest of the world? They cannot” – Mario Draghi

 

Clearly even Draghi feels there is little that the ECB can do in the face of concerns over global growth, tariffs between the US and China, and weakness in emerging markets, but has taken action nonetheless.

 

Table 1: EBC Downgrades Forecasts

Economic Measure

Forecast

2019

2020

2021

Euro zone GDP

Old

1.7%

1.7%

1.5%

 

New

1.1%

1.6%

1.5%

EZ Unemployment

Old

7.8%

7.5%

7.1%

 

New

7.9%

7.7%

7.5%

 

The above forecasts, although having been marked down by the ECB, still paint a rosier picture than what the actual data is telling us.  While there are 19 countries in the euro zone, there are really only three that matter in terms of economic performance.  The “Big Three” are Germany, France and Italy, which between them produce circa 70% of the Eurozone GDP.  If the Big Three sneeze, the euro zone truly does catch a cold.  As the chart below shows, the health of the Big Three looks very shaky.  As of the time of writing, it is highly likely that at the very least, Italy is already in recession.

 

This poor economic performance comes at a time when two of Germany’s largest banks, Deutsche Bank and Commerzbank, are struggling to turn around their dwindling performance.  Deutsche’s credit rating is 1 notch above junk status at the moment according to Moody’s, and another downgrade will see their funding costs move considerably higher, resulting in what will likely be a downward spiral and a significant reduction in the size of their loan portfolio. The slowing economy has made the turnaround very difficult, and it looks like the most likely outcome will be a merger of the two banks.  This is quite possibly the only solution for the survival of Germany’s two biggest lenders to small- and mid-sized companies, which are Germany’s growth engines.  The government is in favour of the merger, as is the ECB.

 

All of this smacks of desperation by both the fiscal and monetary policy makers in the euro zone. 

 

Chart 1: Big Three GDP – Look out for the “R-Word”

 

What Does This Mean for the EUR?

As is always true in the currency world, all discussions around currency strength are based on a relative measure to another currency.  As the majority of our clients are interested in USD, EUR, GBP, and CAD, we will focus on these currencies.

 

There are very few, if any bright spots in the world at the moment. The markets have now completely priced out any further rate hikes by the US in 2019, and many are now looking for rate cuts in 2020, as protectionism, trade wars, and the economic cycle weigh on the US and Global outlooks.  The UK faces Brexit-related challenges and the uncertain future that any outcome will bring. Canada, as a commodity based currency, and a country heavily reliant on exports for its GDP, 70% of which go to the US, will clearly be hurt by a US slowdown, exacerbated by a global slowdown.  There has seldom been a tougher time to point to a likely winner in the battle for FX supremacy, and the market is very divided on who will come out on top.

 

As the bad news continues to hit the wires for all of these countries, clients should brace themselves for an increase in currency volatility, and protect themselves from FX-related losses on their businesses through a well thought out hedging strategy. 

 

 



 

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