Market Noise

There is no ‘magic formula’ QE. The Eurozone had already been recovering.

A Bloomberg headline yesterday provided the breaking news that the “ECB Bolsters Economic Recovery”. The article covers the latest European Purchasing Managers’ Index (PMI) numbers from Markit Economics, which indicate expansion in much of the Eurozone.

We believe the longer-term trend in European PMIs is a reasonable indicator of gradual economic recovery in the Eurozone. But any supposed link between the January 2015 reading and last month’s announcement of quantitative easing (QE) from the European Central Bank (ECB) seems somewhat far-fetched, impossible in fact.  Besides the fact that QE will not even begin until next month and the PMI numbers are based on survey responses collected during January, PMIs in most of the Eurozone have been on an upward trend for several years now (see chart below), albeit it with some significant dispersion – Spain’s recovery recently being particularly notable.

European composite PMIs

The announcement of quantitative easing by the ECB may feel like a significant development, and it may be in terms of sentiment. Since 2008 we have seen a market obsessed with policy action, and often very meaningful responses in terms of price movements across assets to even the most seemingly inconsequential comments of policymakers, at least in the short term. In this environment, arguably, the key role central bankers play is in managing expectations, rather than economic conditions. This is true in terms of both the role investor sentiment plays in driving financial markets and the role that confidence levels of businesses and consumers play in driving genuine economic growth.

However, QE does not in itself guarantee strong recovery for the Eurozone. For this, we would need to see more underlying earnings growth and structural reforms in key countries. There is no real empirical evidence to conclusively prove to what extent QE works in stimulating economies, if at all. We are always careful not to overestimate the link between policy action and genuine economic conditions. In the years since the global financial crisis, the role of central bankers, in terms of the scope of factors they are expected to be able to influence, has expanded considerably. The factual evidence of how successful they have been is rather inconsistent across regions and time periods. QE is not a magic formula that will fix the Eurozone’s economic problems by itself. Mario Draghi himself alluded to this at the press conference following his announcement, when talking about QE as a “first step” and added that spending, investment and structural reform are also required to provide a sustainable, meaningful boost to growth.

When we look at the longer-term trends in the data, although we could not say Eurozone recovery looks anything other than modest, there is a case for arguing the ECB has finally resorted to QE just at the point that austerity has finally begun to work. In any event, QE is unlikely to do any harm, but we must wait for some time yet to see if it will do any good.


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