The Aussie dollar rose past 93 US cents overnight in the wake of the move by the European Central Bank to cut interest rates to record lows and introduce a new series of funding measures to try and kick start the eurozone economy and choke off the continuing slide in inflation.
The ECB moves will pump hundreds of billions of dollars into Europe’s economy and into the financial system of the world. But the impact will be slow and could take years to generate a rebound in activity.
At a time when the Fed is cutting its huge spending, and will be finished by October, the ECB moves will mean the flood of liquidity in global markets will be maintained.
The ECB has been forced to take this controversial set of measures because of the looming spectre of deflation – inflation rose by just 0.5% in May (as reported earlier this week), sharply lower than the 2% target.
The ECB last night cut its inflation forecasts for the rest of the year – it now seems inflation of 0.7% instead of the 1% rate seen in March and the 2% level won’t be reached until well into 2017, instead 2016.
The ECB also cut the eurozone growth estimate this year from a weak 1.2% to a sickly 1%.
This all means the Aussie dollar will be under more upward pressure because the carry trade (borrow cheaply in Europe and invest in a higher yielding currency such as the Aussie dollar).
That will place further pressure on exports and the Federal budget, and could keep a lid on employment and investment growth.
The Aussie traded around 93.40 cents, up more than half a cent in Asia this morning.
The local stockmarket will start up around 10 points, according to the futures market.
The ECB move saw the euro fall, then rebound in something of a surprise, short term interest rates in the eurozone fell, but longer dated yields rose as investors took heart from the ECB measures.
Wall Street had a good night with all three major indexes ending trading higher with the Dow and the S&P 500 ending at new record highs.
The S&P 500 ended up nearly 0.7%, to end at 1,940.46, after morning fall. It was the index’s 17th record close this year and followed the 16th on Wednesday.
Investors around the world are now watching for the US May jobs report and tipping more than 200,000 new jobs to be reported.
The Dow jumped 0.6% to end at 16,836.11, which was also a new record close. Nasdaq rose 1.1% to end at 4,293.23 and the Russell 2000, which covers small cap stocks, jumped 2% to end at 1,153.94.
Gold rose, oil fell and US bond yields traded a touch lower at 2.59% for the key 10 year security.
The measures unveiled by the ECB head, Mario Draghi were much broader than markets expected.
Two years ago, Mr Draghi saved the eurozone by pledging "whatever it takes" to prevent its collapse, by pledging to buy as many bonds as it would take to back the markets. But not a cent was spent. His word was enough.
Last night he produced a series of measures that take the ECB and the world economy into unchartered waters, even after the quantitative easing measures of the US Federal Reserve, the Bank of England and the Bank of Japan.
In a series of announcements, the ECB cut its key interest rate (its equivalent of our cash rate) to 0.15% from 0.25% and dropped its deposit rate (the rate paid to banks who leave cash at the central bank) to minus 0.10% from zero.
In effect the ECB is now the first major central bank to charge banks for the privilege of leaving cash with the central bank (The central banks of Sweden, Denmark and Switzerland have charged negative rates in the past for limited periods). The Fed, Bank of England and Bank of Japan ever went that far.
That is being done to try and get banks to take their cash and start lending it.
And the ECB will lend the eurozone banks 400 billion euros in an operation similar to the long term funding operation two years ago. It will be similar to the Bank of England’s funding to lend scheme in that eurozone banks will be only able to access the money if they lend it to business.
And in a smaller version of the Fed’s quantitative easing, the ECB will then buy asset backed loans, pumping more money into the financial system of Europe, and the world.
That will be aimed at kick starting the asset backed securities market to try and encourage banks and others to sell their loans and generate more cash to lend back to customers.
As well, the bank will stop its weekly operations which absorb the money the bank has previously spent buying bonds. This is called ‘sterilisation‘ and will inject even more money into the eurozone economy.
The takeaway: These measures were well telegraphed and represent a dramatic widening of the ECB’s attempts to halt the disinflationary slide. But they have all been tried before – rate cuts, long term lending to banks (which started in 2008 and expanded in 2011) and nothing has really worked to boost the eurozone and stave off the slide in inflation.
That’s why many in the markets, while welcoming the measures (they are a year late according to many analysts), reckon the ECB will have to go further. If deflation takes hold across the eurozone and it faces the prospect of experiencing what Japan went through for two decades.
The 400 billion of loans to banks to boost lending to business will depend on demand for finance, which has been weak because the economy is weak (apart from Germany and Austria). it’s a chicken and egg argument – which will only be resolved by higher growth across the eurozone as a whole.
It means years of low interest rates, sluggish demand, a slow fall in unemployment and not much growth. – It could be the early years of next decade before the eurozone is back to some sort of rude health.
It has taken the US economy six years to really stabilise and recover from the onset of the GFC in 2008, but even now the recovery isn’t convincing. And the US faces official interest rates at record lows for another one to two years.
And for Australia? The ECB moves mean more upward pressure on the dollar as investors chase our high returns on bonds and some shares, such as the banks.
The ECB measures will make life tougher for us when they should have been improving as the Fed withdraws its spending.
