What Investors Need To Watch In Europe

Europe might seem far away, but given the interconnected nature of the economy today, it might also be of interest for local investors here to be aware of big developments there.  So, let’s get started.

Surprise!  Rate cuts are on the way

On 4 Sep 2014, the Governing Council of the European Central Bank (ECB) took analysts by surprise when it announced several monetary policy measures designed to kick-start economic recovery in the Eurozone.

In the face of disappointing growth and a low inflation rate, the ECB ended up slashing all three of its main interest rates by 10 basis points (0.1%). In addition, the bank also announced stimulus programs to push money into the flagging euro zone economy.

As part of its interest rate changes, the ECB trimmed its benchmark refinancing interest rate (the rate banks pay the ECB) to 0.05% from 0.15% and also cut its already negative overnight deposit rate from minus 0.1% to minus 0.2%. This means that European banks will now have to pay 0.2% to keep their money at the ECB. These moves are made by the ECB to encourage banks to lend more instead of depositing their money with the central bank. In turn, the ECB hopes that the lower rates will stimulate more lending and boost growth.

Meanwhile, the stimulus programs involve the purchase of bundled loans and covered bonds (known as Asset Backed Securities). The operational details of the purchase program would only be announced in October. While the quantum of purchases was not disclosed, the program would increase the ECB’s balance sheet by a sizeable amount; according to the Wall Street Journal, the intention of Mario Draghi, President of the ECB, is to increase the size of the bank’s balance sheet from €2 trillion currently to around €2.7 trillion.

These steps taken by the ECB have come only within three months  of a historic package of stimulus measures unveiled on 5 June, when the ECB became the first major central bank to take one of its main interest rates below zero.

What do these measures mean?

As the inflation rate in Europe remains depressed at 0.3% (much lower than the desired level of 2%) for August, it is threatening the economic recovery of the area. The two-pronged approach by the ECB of buying assets and cutting interest rates is set to boost investments and growth by making credit cheaper; in the process, it can also help stem the region’s slide into possible deflation.

Going forward, with the ECB’s stimulus plans and a prolonged low interest rate environment, European stock markets might react in the same way that the U.S. stock market had done (that is, moving up) when the United States Federal Reserve’s own Quantitative Easing programme was announced. Investors can also take heart in Draghi’s pledge at the height of the European debt crisis in 2012 that he will do “whatever it takes“ to save the euro from collapse.

Consequently, people who are interested in plowing their money in the Euro-zone can look towards the Lyxor ETF MSCI Europe (SGX: JC5) as a viable option. The Singapore-listed exchange-traded fund tracks a large swathe of European shares as its underlying benchmark is actually the MSCI Europe Index.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor James Yeo doesn’t own shares in any companies mentioned.