Draghi took an upbeat tone on the economy, referring to the success of monetary policy decisions in improving credit conditions and easing the cost of financing to households and businesses and thus leading to a broadening out of the economic recovery. On inflation, the near term outlook is not as rosy. The weaker oil price leads the ECB to believe that inflation will remain low or negative for some time and inflation is expected to be 0% this year before rising to 1.5% in 2016 and 1.8% in 2017.
What does all of this mean for investors? The upbeat outlook on the eurozone economy should not be overstated. The economic data from the region over the first few months of this year does point towards building economic momentum and a faster pace of growth over the first quarter of 2015 compared to the end of last year. However, in Mr Draghi’ s own words “other areas of policy need to contribute for monetary policy to have full effect”, that is to say there is still a heavy reliance on national governments to push ahead with structural reforms and geopolitical risks remain high on the list of risks.
European equity markets should continue to move higher this year as the economic fundamentals improve and earnings growth is delivered. However, after the strong run over the first part of the year and valuation metrics no longer as attractive as they once were a selective approach to sectors and companies would be required. Government bond yields should continue to be pushed lower by the ECBs bond purchases and spreads in peripheral bond markets narrow further, however, with yields at these low levels capital gains may be limited. Meanwhile, other segments of the bond market will continue to be supported by the ongoing search for income.
Stephen Macklow-Smith, head of the European Equities Strategy Team, J.P. Morgan Asset Management, said:
The ECB’s purchases of bonds will compress yields even further, increasing the number of instruments trading with negative yields – and this now includes corporate debt as well as sovereign debt. Demand for the yield premium still on offer in sovereign bonds such as Italy and Spain is likely to keep their borrowing costs very low. At some point asset allocators are likely to be forced to look at other instruments, and these should include equities. Three years ago equities offered a less compelling investment because of the risks that loomed over individual countries and the concerns about the overall structure of the Euro. Now however, there are signs of growing strength in economies both inside and outside Europe (important because of the weight of export earnings in quoted Europe). This year’s economic releases have exceeded expectations, fiscal headwinds have more or less evaporated, energy prices have fallen, Euro weakness is aiding competitiveness, unemployment is falling, real wages are rising in the core, bank credit is on the rise, and growing confidence among households and companies should trigger a wave of investment to replace aging assets. It’s a good environment for European stock pickers.
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