Europe needs quantitative easing but that monetary policy alone will not restore growth and jobs to the region, that’s according to a panel debate of business leaders and policy-makers, held at the World Economic Forum in Davos, Switzerland, yesterday.
“We’re all for quantitative easing in Europe, but it’s not enough,” said Lawrence H. Summers, Charles W. Eliot University Professor, Harvard University, USA. Summers said that quantitative easing was likely to be less effective in Europe than it was in the US since Europe already has very low interest rates and European banks are less able to transmit monetary expansion to the wider economy. Summers urged Europe to embark on fiscal stimulus and said that “deflation and secular stagnation are the risks of our time”.
Gary D. Cohn, President and Chief Operating Officer, Goldman Sachs, USA, said that the US economy is strong but weakness elsewhere would make it hard for the Federal Reserve to raise interest rates. He said the dollar’s strength, which could have a chilling effect on the US economy, would also encourage US monetary authorities to keep rates low. “We’re in a currency war. One of the easier ways to stimulate your economy is to weaken your currency,” he said.
Ray Dalio, Chairman and Chief Investment Officer, Bridgewater Associates, USA, said that a weaker currency has to be part of the solution for Europe’s problems, given many European countries’ lack of competitiveness. “Forceful QE and forceful structural reforms, including currency adjustment, are what is needed,” he said. Dalio expressed concern that with interest rates at or near zero, central banks have lost their traditional method for stimulating economies. Fiscal policy now must work together with monetary policy to stimulate growth. “Monetary policy that helps fund deficits, that monetizes the deficits, is a path to consider.”
Dalio added that “Spain has done a wonderful job with structural reforms. It is a model.” He noted that the fastest growth often comes from countries that successfully implement structural reforms, such as China in the recent past.
Christine Lagarde, Managing Director, International Monetary Fund (IMF), Washington DC; World Economic Forum Foundation Board Member, also complimented Spain on its reforms. She said that Europe’s monetary union is still quite young but has nonetheless moved forward quickly. “Massive progress has been made in the last five years. More progress has to be made in terms of fiscal union and banking union.”
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“I am confident that Europe can make it,” added Ana Botín, Chairman, Banco Santander, Spain. She said Europe is now seeing a great deal of foreign investment, including in her own bank’s recent capital rise. Some European countries are successfully implementing structural reforms to increase competitiveness. Automobile factories in Spain are now more productive than those in Germany. “We are making progress,” she said. “It takes time for a region to unify.”
This afternoon, Mario Draghi, President of the European Central Bank (ECB) announced the much awaited outcome of the Governing Council’s meeting on quantitative easing (QE) for the Eurozone economy.
First, the ECB is to launch an expanded asset purchase programme, encompassing the existing purchase programmes for asset-backed securities and covered bonds. The expanded programme will see monthly purchases of €60 billion set to run for 18 months or until required.
Starting March, the Eurosystem will start to purchase euro-denominated investment-grade securities issued by euro area governments and agencies and European institutions in the secondary market. The purchases of securities issued by euro area governments and agencies will be based on the Eurosystem NCBs’ shares in the ECB’s capital key.
Second, the Governing Council decided to change the pricing of the six remaining targeted longer-term refinancing operations (TLTROs). More details will be released on this later.
Third, a decision was taken to keep the key ECB interest rates unchanged. The main interest rate remains at 0.05%, the marginal lending rate stays at 0.3% and the deposit rate at -0.2%.
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“Today’s monetary policy decision on additional asset purchases was taken to counter two unfavourable developments. First, inflation dynamics have continued to be weaker than expected. While the sharp fall in oil prices over recent months remains the dominant factor driving current headline inflation, the potential for second-round effects on wage and price-setting has increased and could adversely affect medium-term price developments. This assessment is underpinned by a further fall in market-based measures of inflation expectations over all horizons and the fact that most indicators of actual or expected inflation stand at, or close to, their historical lows. At the same time, economic slack in the euro area remains sizeable and money and credit developments continue to be subdued,” stated Mario Draghi, President of the ECB.
“Second, while the monetary policy measures adopted between June and September last year resulted in a material improvement in terms of financial market prices, this was not the case for the quantitative results. As a consequence, the prevailing degree of monetary accommodation was insufficient to adequately address heightened risks of too prolonged a period of low inflation. Thus, today the adoption of further balance sheet measures has become warranted to achieve our price stability objective, given that the key ECB interest rates have reached their lower bound.”
According to Mr Draghi, today’s measures will decisively underpin the firm anchoring of medium to long-term inflation expectations.
“The sizeable increase in our balance sheet will further ease the monetary policy stance. In particular, financing conditions for firms and households in the euro area will continue to improve. Moreover, today’s decisions will support our forward guidance on the key ECB interest rates and reinforce the fact that there are significant and increasing differences in the monetary policy cycle between major advanced economies. Taken together, these factors should strengthen demand, increase capacity utilisation and support money and credit growth, and thereby contribute to a return of inflation rates towards 2%.”
The finance industry has been quick to pass comment on the QE measures.
“The size of the ECB’s programme, combined with its potentially open-ended nature, should convince markets that Mario Draghi is committed to fighting deflation,” said Ben Brettell, Senior Economist, Hargreaves Lansdown.
“In many ways the fact that Draghi has finally been forced to use his silver bullet is a measure of how bad the economic situation in Europe has become. Bundesbank officials have made it clear they don’t think economic conditions warrant QE, but few outside Germany would agree that today’s measures are anything less than necessary.”
John Cridland, CBI Director-General, said: “At the moment, flagging Eurozone economies are dragging on UK and world growth. QE will give the Eurozone recovery a much-needed boost, which should also have a positive economic effect in the UK.
“To gain maximum effect though, this action must go hand-in-hand with structural reform. France needs to work with the business community to modernise its labour rules and Germany should invest more in infrastructure.”
While QE has been largely welcomed, Europe faces another challenge later this week when Greece goes to the polls. A victory for the anti-austerity Syriza party could escalate ‘Grexit’ fears amid negotiations over new bailout terms when the current deal expires in February.
Petro Poroshenko, President of Ukraine
President Petro Poroshenko of Ukraine told participants at the World Economic Forum Annual Meeting that despite the aggression his country faces, Ukraine is strong and unified. “Ukraine has become stronger. Ukraine has become more democratic. And Ukraine has become more European,” he said.
In a special session on The Future of Ukraine, held yesterday at the Annual Meeting, Poroshenko said that last year’s presidential and legislative elections were free and fair. He added that these elections showed a highly unified country, while polls indicate that support is stronger than ever for the country’s territorial unity and for integration with the European Union.
Poroshenko said that last year was “the most difficult in our history”, with parts of the country occupied by foreign troops. However, he also saw strong motives for optimism that peace can be achieved. He noted that shelling has fallen dramatically since a December agreement that called for “artillery silence”.
Poroshenko asked for the international community to continue its support of Ukraine, with political solidarity, with economic aid, and with the provision of defensive military technology. “We are not only fighting for our territorial integrity and independence, we are fighting for European values,” he said.
Ukraine is fully committed to economic reform, Poroshenko said. “We want to create a new country, free from corruption, with independent courts and the rule of law. We want to build a new climate for investment.” The country is already cracking down on corruption with a new anti-corruption bureau, and it is reducing bureaucracy. It is working to achieve energy independence from Russia through a mix of conservation, new suppliers and a clear, transparent energy market that will increase domestic shale gas production.
Poroshenko said that in Davos he has received several promises of major investment, as well as many expressions of support for his country. “I am thankful for this support. It is what Ukraine needs,” he said.
The IMF has cut its global growth forecast for 2015 to 3.5%, down 0.3% from its October prediction. It expects a lower oil price to be positive for the global economy, but to be offset by negative factors.
The IMF believes a lower oil price will stimulate more growth in advanced economies that import oil rather than in emerging economies, as the benefit feeds more directly through to consumers. In many developing nations, like India, the government subsidises energy consumption, therefore the government tends to benefit from price drops.
However, the IMF believes the US will see strong growth in 2015, helping push the global economy upwards. The US is forecast to see 3.6% growth in 2015, up 0.5% from the IMF’s October forecast.
Meanwhile the IMF sounds notes of concern over Russia, and China. The Russian economy is expected to contract by 3% in 2015, while China is expected to grow by 6.8%, a 0.3% reduction from October's forecast. This follows on official data just released showing Chinese growth slowed to 7.4% in 2014, an enviable level of growth for advanced economies, but its lowest level in 24 years.
European growth has been downgraded and is now expected to come in at 1.2%, down 0.2% from October. However, Spain provides a European bright spot, with 2% growth expected this year, up 0.3% on October's forecast. The UK is expected to grow by 2.7% in 2015, unchanged from October.
“Economic forecasts of this nature are more like a dowsing rod than a GPS tracking system, but they do confirm what market behaviour suggests- that uncertainty has increased in recent months,” said Laith Khalaf, Senior Analyst for UK-based financial service company Hargreaves Lansdown.
“The falling oil price is of course a major source of instability, though as the IMF notes this should be a boost to global economic activity, albeit with winners and losers.
“The US remains teacher's pet, with the growth forecast for the world's most influential economy revised sharply upwards. At the other end of the spectrum Russia is expected to suffer a 3% contracting in its economy over 2015, as a result of its high exposure to oil and gas production.
“While the IMF strikes a largely negative tone, stock markets have already absorbed much, if not all of the information referred to in these forecasts. For instance Russian and Chinese stocks are already looking relatively inexpensive by historical standards, while US companies are more fully valued, reflecting the respective conditions and confidence in these economies.”
Swiss National Bank headquarters
The Swiss National Bank (SNB) put European financial markets in a spin yesterday when it announced it would no longer be pegging its currency, the Swiss Franc, to the euro. SNB is discontinuing the minimum exchange rate of CHF 1.20 per euro.
The banking institution said that it was taking the step to counteract devaluation of its currency. The minimum exchange rate was introduced during a period of exceptional overvaluation of the Swiss franc and an extremely high level of uncertainty on the financial markets. This exceptional and temporary measure protected the Swiss economy from serious harm. While the Swiss franc is still high, the overvaluation has decreased as a whole since the introduction of the minimum exchange rate.
“Recently, divergences between the monetary policies of the major currency areas have increased significantly – a trend that is likely to become even more pronounced. The euro has depreciated considerably against the US dollar and this, in turn, has caused the Swiss franc to weaken against the US dollar. In these circumstances, the SNB concluded that enforcing and maintaining the minimum exchange rate for the Swiss franc against the euro is no longer justified,” the bank said in a statement.
FX expert Philippe Gelis, CEO and co-founder Kantox believes the Swiss National Bank’s decision to abandon its currency ceiling yesterday could prove as a precursor to countries leaving the euro altogether.
“Of course Switzerland is not a member of the euro, but the SNB’s decision yesterday to remove the enforced ceiling of CHF1.20 per euro essentially demonstrated the tax haven country’s complete loss of faith in the currency that it has been pegged to for the last three years,” said Mr. Gelis.
“The main reason for the SNB’s decision is that in order to maintain a low Swiss franc against the euro, the SNB had to sell its franc reserves and buy euros. This led to large increases on the euro reserves they held. In other words, as any private individual might have done, the SNB decided to take its loss on the EUR and quit the game.”
According to Mr. Gelis, the euro could be hitting troubled waters in 2015, especially if the EU considers adopting a programme of quantitative easing (QE). “QE would see investors flee from the euro to park their money somewhere safer. It is seen by many as the last throw of the dice to rescue the Eurozone, by a central bank bereft of ideas,” he said.
“Added to this, the euro faces Greek and Spanish elections this year, whose results may well see far-left, anti-austerity parties assume power. The Spanish political establishment and the European Union will nervously look to the Greek election later this month as an indicator of what may come for Spain at the end of the year.”
Private equity-backed initial public offerings remained a popular exit route in 2014, according to data published by the Centre for Management Buy-out Research (CMBOR), sponsored by EY and Equistone Partners Europe Limited. New deal activity by volume was higher than 2013, while value rose for the second successive year.
While 2014 did not see any deals above €5 billion, the €1 billion+ market saw sharp growth with 11 deals closing last year – comfortably surpassing 2013 figures.
The €100 million to €250 million bracket also saw growth to report its highest value and volume levels since 2008, while the €250 million to €500 million segment also reached the highest value since 2008.
“2014 was a particularly strong year for the mid-market, which has seen the highest level of deal activity since before the financial crisis. However, this activity has predominantly been led by the exit market; with a huge amount of dry powder ready for deployment across the mid-market buyout funds, the challenge for 2015 will be investing in the right assets at a fair valuation,” said Christiian Marriott, Investor Relations Partner at Equistone Partners Europe Limited.
Total deal values in 2014 reached €61.3 billion – above 2013’s €58.7 billion figure. Deal numbers were also higher: 613 for 2014 versus 562 in 2013. The UK accounted for €18.6 billion followed by Germany’s €11.2 billion and France’s €7.7 billion.
UK buyout value equalled £14.9 billion in 2014 compared to £15.1 billion in 2013.
Sachin Date, EY’s Private Equity Leader for Europe, Middle East, India and Africa (EMEIA) said: “PE-backed IPOs are at a record high since 1998 with 43 PE-backed IPOs worth €44 billion closing in 2014, as financial sponsors continue to capitalise on strong valuations. 2014 also recorded 188 trade sales in exit value terms (€32.2 billion) – the highest since 2011 – and 170 secondary buyouts. 2014 saw the highest value of refinancings ever recorded and has more than doubled since 2012 to the tune of €51.7 billion.
The exit value of above €101 billion is the highest since 2007 and this is only the third time it has crossed the €100 billion mark.
Going into 2015, the European private equity market is expected to steadily improve in line with progress made in the last two years. The pending deal pipeline is around €20 billion in the first few months of 2015.
The Eurozone has slipped into deflation for the first time since October 2009 as the annual change in the Consumer Price Index fell below zero to -0.2% in December, Eurostat reported on January 7, 2015. The unemployment rate across the currency area was reported to have remained steady at 11.5%.
Beneath the headlines, the data continues to mask the mixed realities faced by the currency union's members, especially those to the south of the Frankfurt-based European Central Bank (ECB) who is responsible for maintaining price stability across the bloc, according to Danae Kyriakopoulou, Economist with the Centre for Economics and Business Research (Cebr).
Greece and Spain have already been in deflation for months now (in the case of Greece for almost two years) and have been suffering from unemployment rates more than twice as high as the Eurozone average since mid-2011. In Germany, by contrast, unemployment has been on a downward trend and is now at a modest 6.5%, while annual inflation is still positive at 0.2%.
“This picture may seem puzzling to the eyes of the German taxpayers, who as the largest creditor to the European institutions are becoming increasingly fatigued by the Greek bailout saga. With so many funds sent to Greece and managed under the direction of the combined economic expertise of the troika lenders (ECB, EU and IMF), why are economic indicators in Greece still doing so badly five years on?” asked Ms Kyriakopoulou.
Recent research by the Athens-based economic analysts Macropolis shows that out of the total €226.7 billion that has been supplied to Greece since May 2010 by the troika, only 11% was used to sustain the needs of the Greek state, such as maintaining the provision of basic public goods and services. More than half of the funds have gone back to the creditors in the form of repaying the debt and the interest associated with it, the think-tank reports.
“As recovery remains elusive not only in Greece, but in many other debt-ridden periphery economies and even the currency bloc as a whole, the key question now is what kind of fiscal and monetary policies will be designed in response? Due to their dire economic situation, most periphery countries have little fiscal room to boost their economies through spending, and Germany has pledged to deliver a balanced budget this year,” said Ms Kyriakopoulou.
“The ECB retains a potential silver bullet in the form of quantitative easing (QE) still up its sleeve and ready to be launched. The central bank has a central target for consumer price inflation of 2%. In this light, [Eurostat’s report] undoubtedly raises the pressure on the ECB to act. On the other hand (Liposuction in Dubai), it is worth keeping in mind that the decline in prices was chiefly driven by a 6.3% year-on-year fall in energy prices. This is a ‘good type’ of deflation as it directly translates into a boost for consumers' pockets.
“Given that the ECB has for so long resisted QE even while some countries were in ‘bad’ deflation, there may be little hope in expecting action now that deflation has spread to the rest of the bloc due to factors beyond its control. Overall, Cebr would welcome a move to QE but maintains its view that it would be insufficient to kick-start the recovery. A softer take on austerity and the setting of both fiscal and monetary policies in expansionary mode are imperative to avoid another crisis,” Ms Kyriakopoulou concluded.
