Kick-starting the Eurozone?



Last week’s ECB meeting signalled a further intent to kick-start the eurozone economies with a clear indication of the extension of the ECB’s version of quantitative easing (QE). In March of this year the ECB announced the bond buying programme, repurchasing €60bn of bonds per month, effectively instigating what the US and indeed the UK have done 6 years before.  The effect of this was to push the euro down to its lowest levels against the USD and send government bonds into negative territory.

Anegative returns on 2-year bondss can be seen from the chart, negative returns on 2-year bonds in the euro area stronghold economies is prevalent (and these economies represent the lion share on bond buying recipients).

The most recent meeting has set the tone for a further push on QE in 2015, something that may not have been originally anticipated until 2016. The bond-purchasing programme had also reignited equity markets, with the fall in late August being compensated by the latest announcement of the continued commitment to QE efforts in the euro zone.

One of the outstanding issues is the question of the ECB’s main deposit rate. Currently at -0.20%, it was largely expected that the new QE programme would have sufficient fire power to stave off another cut in the ECB’s deposit rate. But now, all eyes will be firmly on whether the ECB does in fact reduce further the main deposit rate in December, by perhaps another 20bps. This, coupled with a continued focus on bond buying in the bloc, would push the EURO down to even lower levels in an attempt to combat inflation levels in the zone. 

So, where does that leave households on the greater scheme of things? Household debt decreased again in the second quarter of 2015 (from 95.9% to 95% of disposable household income between Q2 2014 and Q2 2015 according to ECB’s latest statistics). Household financial investments, particularly currency and deposits, have grown YoY on a gross basis. However, with bank deposits rates at an all time low, a move to reduce further the ECB’s deposit rate will continue to limit the income derived by households from bank deposits.

The likelihood of an interest rate rise in 2016 is now looking extremely low while a policy of QE remains in place. However, there are a significant number of factors that will impact the performance of the Euro area economies in 2016. Recovery for the large part (and core to the ECB’s monetary policy) will be maintaining a weaker Euro. Continued low oil prices (oil prices have reduced by over 40% YoY), a weakening Chinese economy, favourable production conditions (although industrial output reduced in the Euro area in Q3) and falling unemployment are all contributing to a slow, delicate recovery of the euro area. Q4 2015 has started on a reasonable footing, but unfortunately we have been here before. Greece remains volatile and more recent political events in Portugal and the refugee crisis across Europe puts a severe strain on this volatile recovery.

Banks in the Euro area need to prepare for this recovery, even if the horizon remains uncertain. The general expectation is that inflation rates will average just over 1% in the euro area. Outlook for the economies has been raised in 6 of the 19 countries, with expected growth in 2016 being ~2%. Through 2016, a cautious outlook may see current monetary policy for the area adjust in the second half of the year. The first signals of interest rate rises will help banks to return to normality of interest rate polices and recoup the reducing net interest margins of deposits and lending. Being prepared for these changes takes time and as a result, more banks are examining their deposits base and planning for the events of rising interest rates. Being prepared ensures that banks can more accurately predict and implement strategies for deposit pricing. The opportunity for improvements in margins as well as the opportunity to increase stable funding as a result of higher interest rates remains a key goal for banks as we enter 2016. Analytical modelling, testing in the market and understanding consumer behaviours are all ingredients in these preparations. The more depth to these ingredients, the more accurate the outcomes and the more return on opportunities presented.

About The Author

Damian is a career banker with more than 25 years of experience. He spent most of his career with Bank of Ireland where he held a number of senior roles, including Head of Deposits and Current Accounts, Head of SME Banking and Head of Customer Management and Customer Analytics. At Nomis, Damian is Managing Director responsible for the APAC region.