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ECB joins major Central Banks in monetary stimulus

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In light of the recent rapid spread of covid-19 outside of China, government imposed controls have led to lower volume of business activity and consumer spending which serves as a direct hit on company sales and consequently also on profits. Combine the travel bans and regional quarantines with a drop in lower crude oil prices and central bank stimulus of lower interest rates, and investors find themselves expecting lower earnings across energy companies and lower net interest margins for financial firms. As a result, given that earnings estimates for the near term are expected to be directly hit, this has led to significant repricing in equity markets.

Amidst the market correction, the focus has shifted on governments and monetary authorities who have the available tools to try and cushion the economic impact from the current pandemic.

As expected, the ECB Governing Council yesterday announced monetary policy stimulus amidst concerns that the coronavirus outbreak can push the Euro area into a recession. Pressures have been mounting over the past weeks for the ECB to join other major central banks in injecting stimulus in the economy. In the US, the Federal Reserve surprised markets with a 50 basis point emergency rate cut outside of a scheduled monetary policy meeting. The emergency rate cut came ahead of expectations for weaker PMI numbers, trade balance reports and consumer sentiment indicators, due to rising concerns about the spread of the coronavirus. In the UK, the Bank of England took a similar stance, with monetary easing initiatives announced this week. The Bank of England announced a decline in interest rates and a new Term Funding scheme for small and medium-sized businesses to help cushion the impact of economic disruptions.

Falling in line, the ECB also voiced its concerns over the spread of the coronavirus and its negative implications on economic growth in Europe. Yesterday, the ECB President Lagarde announced three key monetary policy decisions: additional longer-term refinancing operations (LTROs), additional lending support to small and medium sized businesses through TLTRO III operations and an expansion to the net asset purchases program. The ECB decided to add an additional stimulus of €120 billion worth of net asset purchases until the end of the year, described as a “temporary envelope” to support financing conditions. Surprisingly, the ECB kept the key ECB interest rates unchanged at the negative rate of 0.5%.

Monetary stimulus, however, has so far failed to calm financial markets, with major European equity indices dropping by 12% by the close of trading. President Lagarde’s call for “an ambitious and collective fiscal response” reflects financial markets’ concern that monetary policy stimulus alone will not be enough to counteract the sudden stops in economic activity. The expected impact of covid-19 is no longer anticipated to hit the first quarter but has shifted for the first half of the year. During such market uncertainty, trying to time the bottom continues to prove dangerous and should not be the concern of long term investors. However, focusing on resilient companies and rotating investment portfolios to a defensive sector allocation is more prudent in the short term. Ultimately, only with the right fiscal measures can the economy and thus, financial markets bounce back.

Disclaimer:

This article was issued by Rachel Meilak, CFA Equity Analyst at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.

The Calamatta Cuschieri Traders Blog is available daily on CC WebTrader. Other market coverage including coverage of the International Bond Markets is also available.

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