Rate cut a 'non-event'
No impact on equity markets is the unanimous verdict on the recent interest rate cut by the European Central Bank (ECB).
“I do not consider the cut to be a success,” says Dominic Sanasi, who is senior institutional portfolio manager at Bank Degroof in Brussels. “Interest rate cuts have a long term effect. Immediate effects are momentum driven, you generally have to wait six months before you see any real impact.” He would have preferred to see a cut after the summer when the markets would have been better placed to deal with them properly. “As a result of the bad run we have had for the last 16 months or so , I do not think that we were ready to tell the markets by means of a rate cut that we have bottomed out and are thus ready to start moving upward again.”
He believes that the rate cut was a result of political pressure. “There is no other reason behind it.” He says that this highlights the ECB’s weakness as a leader in the economic arena.
This belief is shared by Jesper Skriver Frandsen at Nordea Securities in Copenhagen. “The rate cut will have no impact, it’s far too little and only serves to emphasise the weakness of the ECB.” He says that the ECB is too focused on controlling inflation and not taking enough care of the growth perspective. “Either we need a central bank that is more offensive or we need a clearly defined structure that separates the central bank from politics.”
He goes further and also suggests that the cut was made in response to political pressure to stop negative talk about Euroland economy going into recession. “Put it a more sophisticated way – it was a psychological move, designed to allay fears of recession.”
A spokesperson at Clariden Bank in Zurich feels that the rate cut was made to curb talk of inflation rising. “Although most people were expecting a reduction soon, there still isn’t too much optimism that rates will continue too fall quickly in Europe.”
Sanasi accuses the ECB of putting out conflicting messages. “One minute they’re talking of inflation but that rates won’t be cut, then bang, they do just that.”
Clariden’s commentator echoed this view, adding that the ECB had contradicted itself by cutting rates to surprise the markets and because the economic outlook had changed. But the size of the cut was considered too small to reflect any significant change in sentiment and surprise is not something that the markets appreciate. “The ECB, like the Bundesbank before it, seems to think that surprising the markets is a good thing, when quite clearly it is not something that they respond positively to. It should be more like the Fed, which at least keeps an open eye before acting.”
Frandsen believes that we have to deal with a new wave of uncertainty, even though we have now got the turnaround we have been hoping for. “What about structural problems in the US economy? We have priced the rate cuts in but what if we start seeing more negative news flow? We may be on the up now, but there will be a massive downside if basic structural problems are not addressed.”
He says that although most economists take the view that Euroland has some degree of independence from the US, equity markets continue to be driven by what happens there.
But it isn’t all bad news. “Analysts have been saying for ages now that we have reached the bottom and we are beginning to see some recovery in semi-conductors, which is the main pointer of a pick-up in IT,” says Sanasi. He believes that, although the IT sector continues to suffer from the “craziness” of last year, analysts and brokers are beginning to give it more attention. He says that other areas, such as small caps, will recover more quickly and this will have a knock-on effect on tech and bank stocks. “Everything will then kick in and the cycle that we have known over the last 10 years or so will start off again.”
Nevertheless, he feels that things will remain flat over the summer and that the ECB rate cut would have been the perfect catalyst to stimulate the markets, had it come later.
At Clariden, the feeling is that things still haven’t quite bottomed out, though Europe is standing up fairly well, if not spectacularly. “Looking globally, Europe is still growing whilst other regions have slowed right down. But the growth rate has been revised downward and is a little stagnant. Since rate interest rate cuts only work after a lag, we probably won’t see any recovery until the end of the year.”
Frandsen believes that it is still quite normal to see volatility in the markets and that people need to start looking at individual stocks rather than sector wide movements. “We need to focus on quality stocks, since there continues to be uncertainty. One day things are up, the next they’re down.”