Draghi surprises with clear signal for more policy easing in December

We’ve been keeping a close eye on European growth recently. We are bullish about growth prospects in Europe and favour European equities over other regions, however growing global growth concerns and currency fluctuations give us more reason to remain watchful on key metrics and policy responses.

Although over the very short term European equities have underperformed their rivals, we don’t believe this is due to deteriorating fundamentals. Instead, we think it is the result of a global risk off environment driven by concerns around global growth. However, because it is still not our central case scenario that global growth will deteriorate significantly from here we feel a Eurozone equity overweight is still the best place to be.

This viewpoint was reaffirmed this week when, although the ECB decided (as expected) to keep policy unchanged, it surprised by clearly signaling more policy easing is in the cards in December.

The reasons behind this signal are the ECB’s assessment that downside risk to inflation and growth are increasing on the back of:

  • The slowdown in emerging markets in general and China in particular;
  • The rise in the trade-weighted euro exchange rate by 6% since April (see chart below);
  • The possibility of a further decline in the oil price. In particular, the ECB has adopted a more nuanced view in the price decline so far after previously attributing it largely to supply factors it now acknowledges weak demand is also playing a role;

In December the ECB will publish its updated macro-economic projections. If these projections for growth and/or inflation are lowered once again it is now very likely the ECB will take incremental steps to loosen monetary policy with a range of policy measures including additional QE and increasing the bond purchasing program.

It is interesting to see the ECB becoming something that can almost be described as pro-active. The fact that Draghi reiterated that the domestic part of the recovery is continuing as expected, including improvements in money & credit growth and looser credit standards, but that concerns around external demand were enough to provide this signal is telling. But it also lines up with our preferred positioning in Eurozone equities and peripheral bonds, both of which are performing well since the announcement.