With a few slivers of light at the end of the recessionary tunnel in the eurozone, it was no surprise to see the European Central Bank leave interest rates unchanged at 0.5 per cent, but in the process it indicated that interest rates would “remain at present or lower levels for an extended period of time”.
This was a change in the modus operandi of the ECB in that it was giving forward guidance to markets about the outlook for monetary policy. This change in approach was greeted with a strong rally in stocks with the markets now able to price in at least a couple of more years of super monetary policy stimulus. The larger European stock markets rose by around 2 to 3 per cent.
The “extended period of time” reference to easy monetary policy dominated ECB President Mario Draghi’s press conference after the official monetary policy announcement. When asked how long that time would be, he chose not to make a definitive comment, but noted that “it does not mean six or twelve months”. In other words, it will be years.
In recent weeks, the unfolding bear market in bonds had seen yields rise appreciably and this was threatening to undermine the expected economic recovery in 2014. Draghi was clearly aiming to puncture this rise in yields with his dovish comments.
Draghi again flagged the possibility of the ECB cutting interest rates below zero, noting that a 50 basis point cut to the current 0.50 per cent rate “is not the lower bound”. This caused the euro to fall against the US dollar to 1.2915, a five week low.
While some recent economic data from the eurozone was slightly encouraging, Draghi again reiterated his view that “the risks surrounding the economic outlook for the euro area continue to be on the downside”, notwithstanding his view that the economy was bottoming out and would return to growth in 2014.
In the past week or so, the hard economic news out of Europe has been reasonable, at least relative to generally gloomy expectations of the market which were for little or no hope of an economic recovery in the second half of 2013.
While the unemployment rate rose to a new record high of 12.1 per cent in May, the rise was less than the 12.3 per cent consensus forecast, in part due to some downward revisions to previous unemployment rates. Within that, Germany has a staggeringly low unemployment rate of 5.3 per cent and is benefitting massively from low interest rates and the undervalued euro. This low rate for Germany is helping to keep the whole eurozone unemployment rate lower than it might otherwise be.
The purchasing managers indices for the eurozone, in aggregate, were encouraging. The composite PMI rose to 48.7 points in June from 47.7 points in May and while it remained below 50 points for a 17th consecutive month, it has been trending higher from the low point during 2012 and could turn positive in the next few months.
Retail sales in the eurozone rose a solid 1 per cent in May, suggesting that GDP growth in the second quarter may be nearer zero than the 0.2 per cent, which was the consensus forecast before the data were released. Consumer sentiment is also rising throughout most eurozone countries.
In other less bad news, the eurozone inflation rate edged up to an annual pace of 1.6 per cent in June and appears to be edging up to a point where deflation risks are fading. A round of slightly higher inflation would help the fiscal consolidation process.
These key indicators suggest the worst may be over for the eurozone, although it is clearly too early to have an optimistic outlook. The eurozone is still a long way from registering GDP growth of 2 per cent, the rate seen as the long run trend.
Certainly the ECB and its president, Mario Draghi, are determined to have easy monetary policy that rekindles economic growth, even if they are a little slow to pull the trigger on easier policy. But another month or two of similar news on jobs, spending, business conditions and inflation just might have global market pricing in a return to respectable growth for the eurozone in 2014.
That would be good news… if it happens.