ECB rate cut & US GDP.

7th November 2013

Ian Copelin, Investment Director, my wealth, comments “The ECB today cut its benchmark interest rate by a quarter point to 0.25% (a record low) after Eurozone inflation dropped to an annual rate 0.7% (the slowest pace in four years).  By persistently undershooting the ECB’s definition of price stability, which is 2% inflation, the ECB risks unanchoring inflation expectations on the downside (policymakers fear deflation as this will encourage consumers to postpone their purchases on the expectation of lower prices in the future, which in turn reduces current demand, which will cause prices to fall further and result in an economic deflation-depression spiral).

With Eurozone interest rates now effectively zero (although in theory interest rates can be cut to 0% or negative, economies cannot operate efficiently with negative interest rates as everyone would start to hold physical cash rather than deposit cash in a bank), it increases the likelihood of the ECB introducing unconventional tools such as quantitative easing (QE) to fight deflation and kick-start the Eurozone economy.

Meanwhile, the US economy expanded in the third quarter at a faster pace than forecast:  GDP rose at an annualised rate of 2.8% after a 2.5% gain in the prior three months.  The market had been expecting growth of just 2%.

However, while this growth is good, it is not great.  The GDP growth was led by the biggest increase in inventories in more than a year.  Household purchases and business investment slowed, with consumer spending increased by just 1.5% (the smallest increase since 2011).

I believe that today’s news not only pushes US tapering further out, but indicates that the ECB is no longer behind the curve (which increases the chances of more monetary stimulus in Europe).  To me this all this adds up to a Goldilocks scenario (i.e. cold enough for central banks to maintain or increase their stimulus, but warm enough for global economic and company profitability growth). I think it’s a promising combination for equity markets!”