Bank's decision on interest rates to be closely monitored
Last week proved to be more eventful than had been anticipated. The euro strengthened by almost 4% against the US dollar, its second largest ever one-day rise. Most European equity markets had been sitting on solid gains, but sentiment changed on Thursday.
There was an across-the-board mark down in prices with most markets losing their early gains and finishing the week in modestly negative territory. What caused the change?
On Thursday, Mario Draghi, the president of the European Central Bank (ECB), announced that its target interest rate would be reduced by 10 basis points and that the bank would continue to support European financial markets by maintaining the current level of quantitative easing.
Markets had been expecting more and I can't help but describe the extent of the reaction, in part at least, as collective petulance.
Although the ECB could have done a much better job of managing expectations, there was somewhat of a short-term knee jerk reaction to the decisions. From talk last week of euro/dollar parity, all of a sudden we were faced with a markedly stronger euro. The economic fundamentals hadn't changed that much in one week.
Markets had priced in a 15 basis point deposit rate cut ahead of the meeting and most analysts also expected an expansion of quantitative easing, hence the measures announced by Mario Draghi did not meet expectations. According to ECB officials, all but five members of the Governing Council supported the policy decision. This week, analysts will have more time to consider the implications of the ECB moves and take more considered positions, as they have started to demonstrate.
In contrast, the Dow Jones finished the week strongly, in response to positive news on the US jobs front. There is now a remarkable degree of consensus that the Fed will increase rates at its meeting next week.
This week the interest rate theme continues, with the Bank of England meeting on Thursday. Although there is no expectation of any rate change, signals from the bank will be closely monitored for any indication of when a move is likely.
While an increase in US rates next week is close to being taken for granted, we should remember that this is the first increase in nearly 10 years and that investor confidence remains fragile. When the current obsession with interest rates fades, we will be back to the fundamentals of growth, productivity and trade.