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Equity markets 2018

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The effects of the ECB policy

Foto: iStock.com

Since the cutting of key-lending rates to almost zero in the Eurozone did not suffice to keep the inflation expectations at their long-term target of slightly below 2%, the ECB Council decided in January to expand the central bank money supply until the accomplishment of the target was foreseeable.

The possible effect on the financial market and the economies are multi-faceted. 1) The excessively low inflation expectations increase. This will cause real interest rates (i.e. nominal interest rates minus inflation) to fall. 2) The currency (i.e. the euro) depreciates vis-à-vis other currencies. 3) A so-called asset price effect is created. The ECB buys bonds with low yields, resorting to the central bank money supply. This keeps bond yields very low (partially even negative). Given that, and because the volume of government bonds investable by the private sector shrinks, investors are pushed into asset classes with higher expected yields (bonds with long maturities, bonds with higher default risk, bonds with higher coupons in a foreign currency). This crowding-out effect supports asset prices. The net worth of the holders of these asset classes increases. 4) The willingness of banks to grant loans is supported by the very low bond yields.

Whether the expansion of the money supply really contributes to the achievement of the inflation target is not exactly uncontroversial. That being said, inflation expectations have really increased, real yields have fallen as a result, the euro has depreciated, the spreads demanded for the default risk have narrowed, and share prices in the Eurozone have risen significantly. The effect is amplified by the fact that important economic indicators have improved as well over the past weeks.

In addition, as the example of the Swiss central bank and its abandonment of the exchange rate limit on CHF/EUR shows, a “promise” can also be broken. Basically the question has to be answered how credible it is for the central bank to expand its money supply until the achievement of the inflation targets seems feasible.

Also, the depreciation pressure on the euro forces other central banks to decide on whether to accept the appreciation of their own currency (USA, Switzerland), or whether to put loosening measures in place as well (Denmark, Sweden). The picture of a depreciation race of the currencies is still valid.
Conclusion: the bond purchases by the central bank will have positive effects on the economies and the financial market in the short run. However, the longer the programme takes without engendering any increase of the overly low inflation towards the central bank target, the riskier the situation will become.

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This document is an advertisement. All data is sourced from ERSTE-SPARINVEST Kapitalanlagegesellschaft m.b.H., Erste Asset Management GmbH and ERSTE Immobilien Kapitalanlagegesellschaft m.b.H. unless indicated otherwise. Our languages of communication are German and English.

The prospectus for UCITS (including any amendments) is published in Amtsblatt zur Wiener Zeitung in accordance with the provisions of the InvFG 2011 in the currently amended version. The simplified prospectus is prepared by ERSTE Immobilien Kapitalanlagegesellschaft m.b.H. and published in Amtsblatt zur Wiener Zeitung in accordance with the provisions of the ImmoInvFG 2003 as amended. Information for Investors pursuant to § 21 AIFMG is prepared for the alternative investment funds (AIF) administered by ERSTE-SPARINVEST Kapitalanlagegesellschaft m.b.H., Erste Asset Management GmbH and for ERSTE Immobilien Kapitalanlagegesellschaft m.b.H. pursuant to the provisions of the AIFMG in connection with the InvFG 2011.

The fund prospectus, Information for Investors pursuant to § 21 AIFMG, the simplified prospectus, and the key investor document/KID can be viewed in their latest versions at the web site www.erste-am.com or www.ersteimmobilien.at or obtained in their latest versions free of charge from the domicile of the management company and the domicile of the custodian bank. The exact date of the most recent publication of the fund prospectus or simplified prospectus, the languages in which the key investor document/KID is available, and any additional locations where the documents can be obtained can be viewed on the web site www.erste-am.com or www.ersteimmobilien.at.

This document serves as additional information for our investors and is based on the knowledge of the staff responsible for preparing it at the time of preparation. Our analyses and conclusions are general in nature and do not take into account the individual needs of our investors in terms of earnings, taxation and risk appetite. Past performance is not a reliable indicator of the future performance of a fund.

Gerhard Winzer

Gerhard Winzer has worked at Erste Asset Management since March 2008. Up until March 2009, he was Senior Fund Manager in Fixed Income Asset Allocation; he has been Head Economist since April 2009.

He holds a degree from a polytechnical college and studied economics and business at Vienna ...

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