European Central Bank Balks At Hiking Interest Rates Due To Weak Eurozone

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Includes: ADRU, BBEU, DBEU, DBEZ, DEZU, EDOM, EEA, EPV, EURL, EZU, FEEU, FEP, FEU, FEUZ, FEZ, FIEE, FIEU, FLEE, GSEU, HEDJ, HEZU, HFXE, IEUR, IEV, PTEU, RFEU, UPV, VGK
by: Real Finance
Summary

On March 7, 2019, Mario Draghi announced that the ECB will delay interest rate hikes until 2020. This is largely due to uncertainty from a global trade war and Brexit.

Mario Draghi has been reducing interest rates gradually down to effectively 0.00% since 2015. He will escape his 8-year tenure without raising any rates.

Serious considerations need to be given on whether the eurozone is heading towards negative interest rates.

Please watch the video below to learn more on the significance of ECB's dovish stance.

Background on the European Central Bank

The European Central Bank (ECB) administers monetary policy for the eurozone, which consists of 19 European Union member states. During 2011, the previous ECB President Jean-Claude Triche raised interest rates twice - from 1% to 1.25% in April, and also from 1.25% to 1.50% in July. In November 2011, Mario Draghi took over the new role of ECB President. Mario Draghi has been reducing interest rates gradually down to effectively 0.00% since 2015.

(Figure 1 - ECB interest rates have been on a downward decline since 2000. Source: TradingEconomics)

Mario Draghi ducked from interest rate hikes

On March 7, 2019, Mario Draghi announced that the ECB will delay interest rate hikes until 2020. This is largely due to uncertainty from a global trade war and Brexit which has caused damage to the eurozone economy. Previously, the ECB said that they would keep interest rates the same "at least through the summer of 2019." This signaled a potential chance of a hike in 2019, but that is no longer the case. Mario Draghi will be stepping down in October 2019 after 8 years of serving. (Lucky him; he's just passing the baton to the succeeding ECB President).

"The weakening in economic data points to a sizeable reduction in the pace of economic expansion that will extend into the current year," ECB President Draghi told reporters.

Specifically, the 2019 GDP growth forecast for the eurozone was reduced from 1.7% to a disappointing 1.1%. He did mention that the 'likelihood of a recession is very low.'

What is the ECB doing with a slowing eurozone?

The ECB just ended their quantitative easing program in December 2018, after inflating their balance sheet by $3 trillion since 2015. However, they are still reinvesting the principal received from bonds maturing. This should continue to provide liquidity to the economy as opposed to tightening.

(Figure 2 - ECB's balance sheet has ballooned since 2008 to a record >$5 trillion. Source: Yardeni Research)

The ECB also announced new cheap loans for banks with the goal of boosting credit to households and businesses. The ECB will lend banks up to 30% of the value of certain business loans. The goal is to spur more business activities if ECB is also shouldering some of the loans. This will begin in September and last until March 2021.

(Figure 3 - ECB's Annual GDP Growth Rate. Source: TradingEconomics)

Performance

Euro Stoxx 50 is comprised of fifty of the largest and most liquid stocks in Europe. The YTD performance for the Euro Stoxx 50 is +11.1%, while the S&P 500 is +12.1%.

(Figure 4 - Euro Stoxx 50 index returns since 2000. Source: Yahoo Finance)

Eurozone likely to follow Japan's path of prolonged negative interest rates

Investors should know that negative interest rates is not out of the question. This means you will pay the bank $100 and expect to receive $99 at a later date. The idea is to force consumers to buy more to "stimulate the economy." Unfortunately, this is not the case as evidenced by the Japanese economy. Instead, consumers are actually more focused on saving money rather than spending since they believe the economy isn't strong and need to preserve as much capital as possible. Additionally, bank customers would liquidate their deposits and hold cash instead if negative rates were introduced. As a result, banks won't be as profitable as they usually borrow on the short-end and lend out on the long-end (i.e., mortgages or car loans).

Please watch the video below to learn more on the significance of ECB's dovish stance.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.