The main event of this week was the ECB meeting in Frankfurt. As we know the economy of the Eurozone is showing signs of weakness with Germany most likely soon entering an official recession: two consecutive quarters of negative GDP growth. The ECB mentioned earlier this year again that the risks in the eurozone are tilted to the downside. Overall markets seem to be in the late stage of a bull market with geopolitical trade risks. The ECB was expected to come with new stimulus to bring back inflation and to avoid further detoriation of the economy in the Eurozone.
What is the main goal of the ECB?
The main goal of the ECB is price stability. They aim to have the inflation in the Eurozone below, but close to 2%. The idea is that the benefits of price stability are substantial. According to the ECB, maintaining price stability on a sustained basis is a crucial pre-condition for increasing welfare and growth potential of an economy. All measures the ECB take are focused on this price stability and should be positive for the Eurozone economy.
Which important measures did the ECB take this week?
- Lowering the deposit rate facility from -0.4 to -0.5%.
The deposis rate is the rate at which banks can deposit reserves overnight at the ECB. It gets more expensive for banks to deposit money at the ECB overnight. The idea is that banks will be even more eager to lend money to their clients which will help investments and give a boost to inflation and the economy. - Quantitive Easing (QE) again by buying €20bln government bonds each month, as long as neccesary.
The idea is that banks take the new money and buy assets to replace the ones they have sold to the central bank. That raises stock prices and lowers interest rates, which in turn will boosts investment. - Two tier system for banks that deposit reserves at the ECB.
To make sure the banks do not get punished too much by the low interest rates, parts of their reserves are exempt of the negative desposit rate facility.
What does this mean for the stock market?
Most of the above measures were already expected by the financial markets, but markets were still happy that they were taken. Stocks markets went up around 0.5%. For the upcoming time, with the measures taken, one can expect that the interest rates stay very low. In Germany the 10-year yield will probably stay below 0% for a while. Even yields in more risky countries like Italy are very low. The Italian 10-year yield is below 1%.
Stocks will probably stay populair for the upcoming time, possibly at least 1 or 2 years. The investor that looks for yield finds it difficult to avoid stocks. Interest rates are low, bond yields are low, the bank account is useless. Companies still make good profits and quite some pay good dividends as well. And maybe interest rates will stay low for a long time to come. There is not a great alternative for stocks.
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