Q€

The ECB announces new policy measures to stimulate the economy

Yesterday afternoon the ECB announced a new quantitative easing (“QE”) programme, involving the purchase of 60 billion euros of bonds every month from March 2015 until at least September 2016. Quantitative easing is a monetary policy tool used by central banks aimed at stimulating economic growth by increasing the money supply, lowering interest rates, weakening the currency, and increasing inflation expectations.

Seeking inflation and growth

The ECB is particularly keen to address weak inflation and weak growth in the Eurozone. Long-term inflation expectations have declined significantly since last summer, exacerbated by the sharp drop in oil prices. The Eurozone fell into outright deflation in December, meaning that prices began falling. Deflation troubles the ECB both because it makes it harder for indebted countries to repay their borrowings and because it tends to supress economic growth. Through QE the ECB aims to restore inflation expectations and return inflation to around 2% in the long term. To support growth, the ECB seeks to lower the value of the euro, thereby improving the competitiveness of exports from the Eurozone.

The effect on Eurozone markets

The euro declined considerably against the dollar in the second half of 2014 in anticipation of this move by the ECB. We expect the euro will weaken further during 2015. Eurozone equities have also been rising in anticipation of this announcement, since a weaker euro is expected to boost the profits of companies exporting from the region. We expect European equities to continue to perform well during the next six months. However, QE does not address all the underlying issues facing the Eurozone and we do not expect economic growth to rebound significantly as a result of the ECB action. Many of the region’s problems are structural in nature, requiring reforms such as liberalising labour markets and raising retirement ages. Without such reforms we do not anticipate strong long-term growth in the Eurozone or long-term outperformance from Eurozone equities.

Wider market implications

More broadly, the additional stimulus by the ECB is likely to provide a modest boost to equities globally. We recommend investors remain overweight equities. The effects on bond markets, however, are both positive and negative. On the one hand, worldwide demand for government bonds has just increased. On the other hand, the ECB has averted deflationary concerns and restored slightly higher expectations for inflation. We recommend investors remain underweight bonds.

To discuss this note or any other matter, please contact Nick Fletcher on 020 3405 2447, or any member of the London Wall Partners investment team on 020 3405 2781.