Eighteen months after European Central Bank president Mario Draghi delivered his “whatever it takes” speech, his conviction is about to be properly tested.
All eyes will descend on Frankfurt tomorrow (22 January) when the Governing Council of the ECB gathers for its monthly monetary policy meeting. The subject topping the agenda is whether the time has finally come to flick the switch on quantitative easing.
Last week, one of the European Court of Justice’s top lawyers ruled that the ECB’s outline for implementing a quantitative easing programme passes muster and is indeed legal.
But Advocate General Cruz Villalón asserted that if the Bank goes ahead, certain conditions must be met. These include that it must not provide direct financial assistance to countries in making bond purchases, that it complies with the principle of proportionality and that it does not distort market prices.
Overall it appears Draghi has little choice but turn the pumps on, given that even before the first week of 2015 had passed more bad news had arrived on the eurozone’s doorstep.
Official figures show inflation across the embattled currency bloc slipped into negative territory during December to -0.2 per cent. This was primarily on the back of the plummeting oil price, with Brent crude dropping below the $50 a barrel level for the first time since May 2009.
Some have suggested the beleaguered union could be on the precipice of entering not only a prolonged period of deflation, but another debt crisis too. Capital Economics chief European economist Jonathan Loynes expects this period of deflation to be longer lasting and potentially more harmful than the brief five-month burst seen in 2009.
He says: “Without a rebound in oil prices, energy effects alone could push the headline inflation rate down towards -1 per cent in the early months of this year and keep it in negative territory for most of 2015.”
On the back of fierce resistance from Germany, the ECB has so far not instigated a full QE strategy. But Hargreaves Lansdown senior economist Ben Brettell believes the latest news puts “near-irresistible pressure” on Draghi to inject further monetary stimulus when the ECB meets.
Lombard Odier chief economist Samy Chaar says: “This forces the hand of the ECB and the data still makes the case for Draghi to act because of recent signals, market expectations, and the Greek saga.”
If the ECB fails to act it could be badly received by markets, which have priced in Draghi taking action.
“While the current period of deflation is likely to persist for now, failure to bring in QE would only exacerbate the situation,” adds Brettell.
Falling energy prices may make it cheaper and easier for companies to manufacture and transport their goods and services, as well as boosting consumers spending power, but the real danger is if inflation expectations turn negative and consumers defer spending.
“Spending decisions will be deferred in expectation of lower future prices and economic stagnation could result,” Brettell argues.
On the plus side, core price inflation, which excludes energy, food, alcohol and tobacco, managed to remain stable during December at 0.8 per cent but the backdrop still does not bode well for investors.
The fact yields on sovereign bonds have fallen to record lows and the euro has tumbled against the dollar highlights that the market is firmly expecting QE to imminently commence, notes Axa Wealth head of investing Adrian Lowcock. “Actual QE is likely to continue to put pressure on the currency to weaken,” he adds.
But while a weaker currency makes it cheaper for Europeans to export and more expensive imports should turn consumers to cheaper domestic alternatives, Lowcock cautions that this does not mean investors should be too optimistic over Europe.
He says: “We are seven years into the recovery from the global financial crisis and the US has only just pulled itself out, whilst Europe has yet to begin any structural reform.”
However, Lowcock admits QE is likely to provide a boost to value stocks, those areas that are undervalued by the market such as banks and cyclical exporters. Brettell points to the QE programmes in the US, UK and Japan, all of which have spurred on dramatic stockmarket rallies. “However, with QE expected to weaken the euro, this could offset gains in sterling terms for those based in the UK,” he says.
On paper it appears the easy money has already been made from the continent. Europe has dramatically lagged behind the now far more economically robust US, where the S&P 500 soared by 20 per cent in 2014, versus the 2.1 per cent drop from the Euro Stoxx index.
In addition, while the Investment Association Europe ex-UK sector has achieved an average total return of 48 per cent over the three years to the end of 2014, that money was not made during the past 12 months. In fact, during 2014 the IA peer group delivered a cumulative mean return of minus 0.94 per cent.
Despite this, Russell Investments senior investment strategist Wouter Sturkenboom says he believes valuations across the eurozone are attractive relative to those in the US.
He says: “Despite recent turbulence, we see a number of positives working for European equities, including positive corporate earnings momentum, a lower euro relative to the US dollar, lower oil prices and favourable fiscal and monetary policy.”