Faced with the growing threat of deflation and slowing growth, the European Central Bank has thrown the dice and launched its last resort – cutting interest rates and starting a program of quantitative easing that could total more than $1 trillion.
The easing will see the ECB purchasing private securities (such as covered bonds, a property related security ) unlike other moves in the US, UK and Japan where the central banks concentrate on government bonds.
The move saw the euro fall below 1.30 US dollars for the first time, the value of the Aussie dollar kicked higher, passing 93.5 US cents and stockmarkets across Europe rose sharply.
In the US markets were more sedate, the Dow, S&P 500 and Nasdaq were all lower at the close, while the price of gold fell $US8 an ounce to $US1,262 and oil prices dropped 1% to around $US94.50 for US type crude oil.
Our market will start flat this morning.
The move will not make the Reserve Bank and Australian exporters happier as it will increase buying pressure on the dollar, meaning it will remain around current levels for much longer than it should.
That will offset any downward pressure on the currency when the US Fed will end its asset purchases in October, a move that was seen as allowing the value of the dollar to fall towards and under 90 US cents, by some analysts.
That still might happen, but the fall will take a lot longer, if past reaction to the easing moves by the Fed and the Bank of Japan, is any guide.
In the wake of the easing, interest rates were mixed in Europe – some longer term bonds eased in an immediate reaction, but a more accurate reaction won’t be seen for weeks.
Bond prices have already risen sharply (driving yields to record lows in Germany for example)
In launching its version of quantitative easing the ECB has joined the US Fed, Bank of England and Bank of Japan in going down the route of printing money to try and stimulate economic activity, inflation and exporters.
This is a last resort for the ECB – if you look at what has happened elsewhere, the move will take a year or more to have an impact on economic activity.
Funnily enough the move took markets by surprise, despite being widely tipped in recent weeks
The rate cut, to the ECB’s refinancing rate, took that key indicator down to 0.05% from 0.15%, and the central bank will now charge banks 0.2% to leave their money at the bank instead of using it.
Mario Draghi, the ECB president, said this was the final rate cut (after indicating a month or so ago that there would be no more rate cuts).
In buying securities, the ECB will target not only Asset Back Securities (ABS) backed by business loans but also residential mortgages. These account for about 70% of the European ABS market.
The central bank plans to buy the high-rated blocks of ABS, as well as their more junior, riskier parts, provided they are backed by guarantees. The ECB could purchase both news ABS and existing securities.
Mr Draghi also announced a scheme to buy covered bonds, which are similar to ABS but remain on banks’ balance sheets.
Tis is aimed at making the purchases broad enough to cover parts of the euro area were asset based securitisation is less common.
The ECB’s move is aimed at halting the slide towards deflation, with the consumer inflation rate falling to 0.3% in August, a five year low.
The ECB cut its projections for growth and inflation this year.
The central bank sees inflation at 0.6% in 2014, 1.1% in 2015 and 1.4% in 2016. That is optimistic .
The ECB expects the economy to grow by 0.9% this year, which is also optimistic given the sharp slow down in second quarter growth and early weak data for the current quarter.
But a bigger influence on markets and the value of the Aussie dollar could be the August jobs report in the US tonight.
A seventh consecutive month of more than 200,000 new jobs is expected to be revealed at 10.30pm our time.
Analysts reckon around 230,000 new jobs were created in August.
The report will be yet another bit of data that will confirm the US is enjoying its strongest run of economic news since the recovery from the GFC began in 2009.
Surveys this week of manufacturing and services point to continuing expansion, retail sales are solid and investment continues.
The health of the jobs market is the only question mark in the mind of the US Fed as it contemplates the timing of its rate rise.
The jobless rate is tipped to fall to 6.1%, but some economists say the flow of good news could see more people looking for work, which would boost the jobless rate.
The jobs report will come less than two weeks ahead of an important US Federal Reserve meeting, where central bank officials will update their economic forecasts, highlighting the possibility of upgrades by the central bank.
But it is also possible the number of new jobs could be closer to 270,000 or more, judging by the strength of this week’s surveys, with the jobless rate dipping to 6% or 5.9%.
If that happens watch US economists bring forward their estimates of the first US rate rise since late 2008.
That in turn would boost the value of the dollar, and put downward pressure on other currencies – where it will meet the upward pressure on currencies from the easing campaigns of the Bank of Japan and now the ECB.
