22nd January 2015
Paras Anand, head of European equities at Fidelity Worldwide Investment looks into on European Central Banks QE plan…
As the details of the ECB’s quantitative easing plan are brought into focus, the debate around the merits of the programme continue in the background. I believe the ECB’s strategy has as many shortcomings as potential benefits and it is hard not to feel a sense of, if not disappointment, then ennui at today’s announcement.
This latest development by the ECB may have a lower than expected positive longer term impact on growth across region for the reasons summarised below. The positive news for us as European investors is that despite such an apparently meaningful macroeconomic event, we see share prices across the region being driven by company specific factors as opposed to shifts in top-down conditions.
Such a widely debated plan clearly has negligible ‘awe’ potential, either in the markets or in the real economy. I wonder whether the ECB’s willingness to expand its balance sheet to stimulate growth had more impact as a latent lever as opposed to one that has been deployed. This position alone was enough to reverse the fears in the credit market that had escalated in the early part of this decade in the creditworthiness of the weaker sovereigns. This gave the financial sector the time to rebuild capital, de-risk their business models and allowed the system to become less tightly coupled.
The internal adjustments within the region, post the boom and painful bust of the last decade, were clearly going to have a profound deflationary element as prices of labour, property, goods and services are re-set to meet the lower level of demand. But we have arguably been too quick to label the current collapse in inflation as structural rather than cyclical. History has shown that the corporate sector across Europe has emerged from each downturn fundamentally stronger, with greater focus on long term shareholder value creation which has driven economic growth within each successive cycle. This, more than anything, is what differentiates the current situation in Europe from the historic situation in Japan. Arguably we should encourage a normal ‘creative destruction’ cycle to take place whereby assets are transferred from genuinely weak hands to strong hands; further monetary easing does not aid this process.
One of the more widely discussed points is the extent to which the ECB, by positioning itself as an ever-present buyer of government debt, eases the pressure on economies that desperately need to enact structural reform to do so. Economies across the region, particularly Italy and France, need to take tough measures today to unlock the longer term potential within their well-educated and skilled labour markets and drive both competitiveness but importantly new business formation. Again, it would seem that quantitative easing in and of itself can help little in this regard.
Finally, there is a valid debate as to whether integration across the region is being abetted or hampered by the structure of the ECB package. Despite recent emphasis on the fissions across Europe from an economic and political perspective, a more dispassionate perspective suggests that over the recent past, the links across the region were quietly rebuilding. Germany is placing greater emphasis on reform over austerity, a synchronised supervision of the key regional banks, the resumption of cross-border corporate activity and importantly a recognition that the rise in populist politics was a shared issue rather than a localised one and was resulting in greater collaboration between mainstream governments across the region. What we have seen, encouragingly, has been a form of pragmatism; a deferral to informal understanding and an attention to the spirit of collaboration across the single market rather than a constant recourse to the rule book. I fear that the current programme with its focus on ultimate recourse and legal obligations under various negative scenarios is pulling us in the opposite direction.