Super Mario springs a surprise

European Central Bank chief Mario Draghi cheered investors with his unexpected interest-rate cut.

The president of the European Central Bank (ECB), Mario Draghi, "managed to shock almost everyone" last week, says the FT's Claire Jones. He cut the ECB's benchmark interest rate by a quarter of a per cent to 0.25%. Stocks bounced and the euro slid to a seven-week low against the dollar.

Why he acted

Deflation increases the real value of debt, as loans are fixed in cash terms. So the burden of public, household and corporate debt, already hampering the eurozone economy, would get even heavier.

The impact of this rate cut, however, is questionable. "The monetary plumbing of the eurozone remains blocked," says the FT. Banks, especially in the stricken periphery, are grappling with losses on loans and remain undercapitalised, so they are loath to pass on the ECB's cheap lending rates to consumers. And demand isn't exactly rocketing anyway, as companies and households already owe too much.

Pushing the euro down

What's more, the way Europe's policymakers view the euro has shifted, says Citi's Steven Englander. They used to be happy with a strengthening currency because it meant investors had become less worried about it breaking up.

But in the past 18 months the immediate danger of the single currency collapsing has passed. Now a weaker currency is good news as it boosts exports.

However, for now, the euro remains at levels "likely to drag on the region's exports and recovery", as Capital Economics points out.

The significance of Draghi's move is that he is showing he is serious about trying to boost the eurozone: the rate cut has been compared to his promise last year that he would buy up unlimited amounts of peripheral bonds to prevent a default.

and stocks up

Further liquidity injections in the form of another round of three-year loans for banks may also follow. "It's a given that in the next six months the ECB will dispense more cheap money," says Liam Halligan in The Sunday Telegraph.

Further monetary loosening to weaken the euro in Europe might cause "tut-tutting" in Germany, which is always worried about inflation. But exporters in Germany, and all over the continent, "know where their bread is buttered".

The broader point is that, while in Europe "the funny-money dials have just been turned up", as Halligan puts it, Britain and America are more likely to reduce the pace of their money-printing programmes.

Last week's unexpectedly strong payrolls and growth figures in the US have reinforced this impression. More central-bank support bodes well for European stocks compared to their British and US counterparts, and they are also cheaper, as we have regularly pointed out. Super Mario is another reason to stick with European equities.

Recommended

The Arab Spring ten years on: a revolution that failed to blossom
Global Economy

The Arab Spring ten years on: a revolution that failed to blossom

Ten years ago, the Arab world was rocked by mass protests and popular uprisings that ousted long-reviled dictators. For the most part, the end result …
23 Jan 2021
The charts that matter: inflation, bubbles, and booze
Economy

The charts that matter: inflation, bubbles, and booze

As US stocks head higher into bubble territory, John Stepek looks at the charts that matter most to the global economy.
23 Jan 2021
The MoneyWeek Podcast: let's talk about bubbles
Stockmarkets

The MoneyWeek Podcast: let's talk about bubbles

Merryn and John talk about the many obvious signs of a bubble in certain assets, including tech stocks, TikTok, and stock-trading 12-year olds. It's c…
22 Jan 2021
Inflation is the easiest way out of this – just don’t expect politicians to admit it
Inflation

Inflation is the easiest way out of this – just don’t expect politicians to admit it

The UK government borrowed £34.1bn in December, a record amount for that month. Britain's debt pile now amounts to 100% of GDP. How are we going to pa…
22 Jan 2021

Most Popular

Why we won’t see a house-price crash in 2021
House prices

Why we won’t see a house-price crash in 2021

Lockdown sent house prices berserk as cooped up home-workers fled for bigger properties in the country. And while they won’t rise quite as much this y…
18 Jan 2021
The world’s fund managers are getting very bullish – be careful out there
Stockmarkets

The world’s fund managers are getting very bullish – be careful out there

The latest survey of fund managers shows them to be extremely bullish on all the same things. And that, says John Stepek, means the market is in dange…
21 Jan 2021
Prepare for the end of the epic bubble in US stocks
US stockmarkets

Prepare for the end of the epic bubble in US stocks

US stocks are as expensive as they’ve ever been. How can you prepare your portfolio for a bubble bursting?
18 Jan 2021