Investing in the eurozone
This week, the European Central Bank finally kicks off its programme of quantitative easing (QE), which will see it pump at least €1.1trn (£800bn) into the European economy over the next 18 months or longer.
The QE programme is aimed at stimulating growth in the European economy by purchasing government and corporate bonds worth about €60bn each month.
When ECB President Mario Draghi announced the programme in January this year, he said it would continue until at least September 2016 or “until we see a sustained adjustment in the path of inflation”. The ECB is currently targeting inflation of around 2% over the medium term: currently it is barely above zero at around 0.3%.
Should you invest?
The answer is not necessarily clear-cut, as is nearly always the case when considering investing. What we do know from historic examples is that QE will almost undoubtedly push some asset prices up, at least in the short term.
When the UK began its first round of QE in November 2009 following the previous year’s stock market crash, asset prices increased, with the FTSE ultimately finishing the year 22% up – at the time its biggest annual gain since 1997 (last week The FTSE 100 hit fresh highs).
Likewise, the US Federal Reserve’s decision to begin pumping money into the economy during 2008, also helped to keep asset prices afloat and stave off some of the effects of that year’s crash – on stock markets at least.
However, as we are all acutely aware, the action taken by both the Bank of England and the Fed was not able to prevent years of economic recession, with no material impact on the underlying growth of either economy for some time (although, while the recession persisted, stock markets continued to rise – albeit with high volatility). In fact, it was only last week that the Institute for Fiscal Studies forecast household incomes had returned to pre-crisis levels.
So in terms of the stock markets, European shares are arguably a good bet, particularly given they are significantly undervalued versus other economies like the US.
Stock markets are also highly driven by confidence. This large scale QE programme will give investors the assurance that their investments are relatively safe – protected by significant amounts of government money.
In the longer term the impact of QE is much harder to predict. Technically, QE should mean more money reaching the lower ends of the economy, with an increase in lending to individuals and small businesses. However, in the UK and US this wasn’t the case and the UK’s so-called “double dip” recession (when it re-entered recession in 2011) was symptomatic of this.
There is, however, one further point to consider. In the UK and US, QE was one of the first significant monetary policies implemented after the financial crisis. However, in the eurozone there have been five years of austerity measures – particularly in southern Europe which has been in a severe and prolonged depression – meaning that government spending has been cut significantly.
This means that these Southern economies may now be better placed to benefit from a QE programme, with the effects more tangible at the bottom of each economy.
According to David Norton, head of investments at AES International, the ECB plans to buy sovereign bonds proportionate to the economic size of its member countries, so that the bulk will come from nations like Germany and France.
“Past QE programmes haven't addressed the fundamental economic problems, and some of Europe's largest economies (France, Italy, Spain, Portugal) still require further reforms which are now likely to be further delayed by QE,” said Norton.
“This could generate political tensions across the European Union, so it will be a diffi cult programme to manage for the ECB.”
From an investment perspective Norton says: “Draghi is being true to his word on doing ‘whatever it takes’ to save the Euro.
“Following austerity measures, a QE programme will be a boost to economic confidence, but it’s difficult to know what more can be done after this. We have become positive on European equities but we remain vigilant: the complications inherent in this easing programme make its outcome far from certain.”