ECB stimulus is a drag on Eurozone financials

The ECB yesterday released a multifaceted policy easing package that includes committing to €20bn per month asset purchase programme, cutting its key deposit rate to -0.5% from -0.4% and guiding interest rates lower.

Commenting on the data, Daniel Casali, Chief Investment Strategist, noted:

“ECB President Draghi gave a dovish message on asset purchases, suggesting that the ECB Governing Council will continue to buy government (and corporate) bonds until “shortly before” interest rates are raised, rather than at a particular end date. President Draghi has essentially linked asset purchases to interest rates, which in turn are dependent on inflation. Given that CPI inflation is just 1%, a long way from the central bank’s 2% target, asset purchases are likely to continue for the foreseeable future.”

“The ECB also ramped up its calls for fiscal policy to do more, underlining the limitations of monetary policy. However, member states, such as Germany, continue to run a fiscal surplus, something that is unlikely to change anytime soon. German finance minister Olaf Scholz has suggested an additional €50bn of government easing could be used in the event of an economic downturn, referring to the cyclical component of the fiscal surplus. The real issue to reduce Germany’s fiscal surplus is to adjust the structural component, but that would require a change in the balanced budget amendment in the country’s constitution, and there seems little appetite for this in parliament.”

“Looking forward, expect increasing demand for Eurozone government securities from ECB asset purchases and fairly tight fiscal policy in the EU to reduce the supply of bonds in the market. A scarcity of Eurozone government securities should keep bond yields down.”

“For investors, one of the unintended consequences of central bank interest rate cuts and asset purchases of government securities is that bond yields have turned negative. This is likely to be a drag on the relative market performance of Eurozone financials, such as banks, which are likely to be weighed down by a lack of profitable lending opportunities in a flat yield curve environment. Banks also seem unable or unwilling to pass on negative interest costs to retail depositors. Furthermore, lower negative interest rates will cost European banks money. For instance, since the advent of negative rates across Europe in 2014, Goldman Sachs estimates that Eurozone banks have cumulatively paid €23bn to the ECB.

“Other Eurozone financials are likely to struggle in a low yield environment. Insurance companies and pension providers are finding it difficult to match assets and liabilities in a profitable way, as purchasing a negative yielding bond locks in a guaranteed loss against a future maturing liability.”

“Increasingly negative rates can become counterproductive. It is not clear that markets have reached that point, but the ECB decision to restart asset purchases is likely to intensify headwinds for financial stocks over the coming quarters.”

Source: Thomson Reuters Datastream, Goldman Sachs, Smith & Williamson Investment Management LLP (data correct as at 13th September)

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