ECB stimulus programme: fund manager reaction

Euro signFund manager reaction yesterday to the European Central Bank (ECB) interest rate cut and an introduction of a bond-purchasing stimulus ranged from "too little, too late", to praise for exceeding expectations. The ECB cut its main interest rate from 0.15% to 0.05%, and the deposit rate was cut a further 10 basis points to -0.2% in response to weak economic data and a drop in long-term inflation expectations. Also, in response to the threat of deflation, the ECB will begin buying a broad portfolio of asset-backed securities and covered bonds in October. The euro fell and stocks rose after the announcement. What follows is a range of reaction from fund houses. Neil Williams, Hermes Group chief executive says the ECB move was "a step in the right direction, but too little, too late to snuff out deflation-risk and kick-start growth". "The further 10 basis points shavings off the refinancing and deposit rates are puny, and look more cosmetic than real. Any drop in the euro on the back of them would be welcome, but possibly short-lived. "The ECB hopes the negative deposit rate (-0.2%) will deter banks from parking cash at the ECB, instead passing it on to consumers and firms. But, this may be a red herring, given still tame credit demand, pressure for the banks to pass stress tests and the fact that the bulk of reserves still gets the (0.05%) refinancing rate. "These rates may have to be cut again - especially if the unfortunate conflict to the east causes an increasingly direct macro hit on Germany's growth. "The ECB's private asset purchases may help, but the amounts are small, and any benefit will fall more to the bigger, core members, Germany, France and Italy, than the periphery. "Far more useful would've been the 'bazooka' of unlimited sovereign QE, which was not fired today [Thursday, September 5]. But, Señor Draghi's clearly leaving his powder dry. His hesitancy to use all bullets reflects how empty the policy tool-box is. With demand subdued and the likelihood at some stage of rising bond yields, the ECB will have to capitulate on QE. "The biggest test will be when global yields start to climb, probably in 2015. Given two-thirds of euro-zone activity is long, not short-rate, driven, this will sap demand. Otherwise, the zone's misery may be compounded by a stronger euro, doing nothing to allay fears that Japan is leading the way in terms of deflation risk." Trevor Greetham, director of asset allocation at Fidelity Worldwide Investment, said there is no further room to cut rates so the focus is now squarely on the liquidity injections and asset purchase programmes already announced. "President Draghi kept the door open to sovereign bond purchases and he continued to talk the euro down by drawing attention to other central banks heading towards tightening. "Most interesting, he repeated his call for a more growth-friendly fiscal stance. As he put it, 'each of us has to do our own jobs' in order to get inflation back to its 2% target. What Europe really needs is a much easier fiscal stance in countries like Germany but that isn't likely. "All told, today's policy changes aren't enough to cause growth to come surging back in the euro area but things are looking brighter in the US where business confidence is strong and consumers are buying cars and houses once more. We continue to prefer the US dollar to the euro and we favour US equities over those in Europe in our multi-asset funds." Martin Harvey, fixed income fund manager at Threadneedle Investments, said: "The ECB exceeded market expectations once again this month, highlighting both the commitment to anchoring inflation expectations, and also heightened concerns that market participants are losing faith after so many months of low inflation prints. The recent drop in inflation expectations inspired both a cut in interest rates and a firm commitment to ABS [asset-backed securities] purchases, which alongside the upcoming TLTROs [targeted longer-term refinancing operation] could boost the central bank balance sheet by up to €1 trillion. "There are certainly question marks surrounding the technical difficulties of large-scale asset purchases, which explains the hesitancy in committing to a specific size, but the policy commitment should be big enough to boost confidence in the ECB's ability to meet its mandate. "This will mark the beginning of quantitative easing, albeit without going down the more traditional route of sovereign bond purchases. Institutional hurdles remain to such a policy but it remains in the armoury if the economic situation were to worsen further. For now, this policy should provide further solace to risk assets and a continuation of the recent 'hunt-for-yield' theme in fixed income markets, at least until we find out how quickly the balance sheet expansion occurs." Gregor Macintosh, head of sovereign, emerging debt and FX at Lombard Odier Investment Managers, said: "While Draghi continues to show his progressive intent, the specific economic impact of the measures he has announced is likely to have less impact than will be delivered by the euro's reaction to his policy initiatives. "The limits of the EU policy framework have so far tied Draghi's hands from delivering full-scale QE, let alone encourage fiscal easing. However, the steepening of the European yield curve, strong rally in peripheral debt and equities suggest investors are initially encouraged about the reflationary impulse of the euro's depreciation." Bill Street, head of investment in Europe, the Middle East and Africa at State Street Global Advisors, said: "The decision to cut interest rates today is a staging post for more aggressive measures to be implemented in the coming months. Cuts in the main refinancing rate and the deposit rate illustrate the continued weakening of macroeconomic data within Europe since the last ECB meeting. "This is taking place with a backdrop of zero inflation and concerns that Europe is heading into a deflationary environment. We expect both cuts to have a muted effect on bank lending while adding to further weakening of the euro's momentum with our current fair value estimate at 1.18. "The announcement of fresh covered bond purchases was a surprise, especially considering market speculation of an ABS purchase programme being announced. We expect [Draghi] to continue to do what it takes with regards to further discussion around the implementation of an ABS purchase programme as well as a broader, more impactful, QE programme." Andrew Bosomworth, managing director and portfolio manager at Pimco, said: "The surprise rate cut and covered bond purchase programme probably reflect that President Draghi does not have unanimity, or a large enough majority, for quantitative easing. "For some decisions, like the ones taken today, a simple majority on the governing council would appear to be necessary. For QE, which is more controversial in some eurozone countries, I think President Draghi will want all governors to be in favour; otherwise, opponents of QE could sabotage its effectiveness. "Deeper negative interest rates raise the opportunity cost of holding euro cash. Companies and investors will try even more to minimize euro cash balances, which will help to further weaken the currency. Lower borrowing costs make the TLTROs marginally more attractive. The ABS and covered bond markets are relatively illiquid. Private demand for ABS and covered bonds is already there. The problem with these markets lies partly on the supply side. Having a non-economic agent like the ECB enter those markets will lower the cost of borrowing, but that that alone won't necessarily induce more supply and lending to the private sector. "I would not expect today's measures to have a significant impact on the real economy, i.e. in raising inflation and growth. They signal the ECB is ready to do more. If more is needed, and I think the odds are still on that more will be needed, it will take the form of QE." Azad Zangana, European economist, and Chris Ames, fixed income fund manager, at Schroders: "In our view, the cut in interest rates is totally irrelevant. Due to the glut of liquidity in money markets, short-term interest rates have been below the ECB's main financing rate for some time – meaning that the latest cut will have near zero impact. "The purchase of ABS is designed to transfer the risk of packaged loans from banks to the ECB, which in theory should free up capital for those banks to increase lending to households and corporates. Of course, there is no guarantee those banks will choose to lend more, especially as some are under pressure from a regulatory position to boost their core capital holdings. "Moreover, according to JP Morgan, the ABS market in Europe is very small. Europe's ABS market is worth approximately €1.2 trillion, but excluding non-eurozone issue, the market is just €885 billion. However, as most of the existing stock of ABS is being used as collateral to access various ECB repo operations, the actual available stock in the secondary market is just €251 billion – barely worth 2.6% of GDP. Compared to the size of the Fed's balance sheet of $4.4 trillion (approximately €5.7 trillion), the ECB's ABS purchases are unlikely to be large enough to make any real impact on the real economy. From the view of market participants, the ECB is also likely to crowd out long-term buyers of the asset class, which may irreversibly hurt the health of the market in the long-term. "The limitations of the ABS market have naturally pushed investors to conclude that the ECB will eventually be forced to buy other assets, but in particular, sovereign debt, in the same way the Fed and Bank of England were. For now, this is not on the ECB's agenda, and if the ECB's staff projections are right in forecasting a recovery in growth and inflation for next year, the ECB may never have to embark down that controversial path." ©2014 funds europe

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