Is the ECB Changing Attitude?

Is the ECB Changing Attitude? - at www.moneyweek.com - the best of the international financial media

The European Central Bank (ECB) is gradually changing its body language. Since it was first established, the ECB has effectively pursued a policy designed to address the average requirements of its member countries. This policy worked adequately, if not brilliantly, for a while. However, with some of the largest member states (i.e. Italy and Germany) lagging further and further behind, the shortcomings of this 'middle of the road' policy have become increasingly evident.

The only alternative open to the ECB is a policy designed to tailor to the weakest link. In other words, rates will be set to meet the requirements of Italy and Germany regardless of the effect such rates may have on faster growing countries. It may take a while, but we think the ECB is heading in this direction. A change of guard amongst European political leaders will only accelerate this change of mindset.

An important point lost on some people is that certain countries in Europe are actually doing quite well at the moment. The ECB is forced to operate one rate of interest across all member countries despite dramatic differences in economic performance (which tells you that Europe wasn't quite ready for a uniform interest rate policy, but let's not go there).

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In some countries (e.g. Spain, Finland, Ireland) the current EURIBOR rate of 2% is highly accommodating. But unlike the 1980s or early 1990s, where such a policy would spark a significant rise in inflation, these countries get away with it because we are in an inflationary "sweet spot" at present. The ECB should count itself lucky. This is a global trend totally beyond their control.

However, given the relatively weak economic outlook for Europe combined with the fact that globalization is only likely to intensify, there is nothing to suggest that inflation will become a problem anytime soon. This is an open invitation to the ECB to change strategy and start pursuing a policy of supporting the weakest link.

If the ECB were to become more aggressive with their rate cuts, European equities should continue to do well. If you are a euro-based investor, a weakening euro can only be an advantage. If you are sterling or dollar based, you can hedge your currency risk with forward contracts. Because sterling and dollar rates are both higher than euro rates, you actually get paid for doing so. Not a bad risk/reward.

By The Absolute Return Team

Absolute Return Partners LLP is a London-based private partnership. They provide independent asset management and investment advisory services globally to institutional as well as private investors, charities, foundations and trusts.

To learn more about them, visit www.arpllp.com