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14 March 2016

Keeping up with the eurozone in 60 seconds

By Sam Slator

If you thought keeping up with the Kardashians was hard work, try keeping up with the eurozone. Same roller coaster drama, but without the fun of cosmetic enhancements, nude pics and scandalous parties.

Much like certain Kardashian assets, the eurozone's challenges just seem to keep ballooning. Economic growth and inflation forecasts were revised down last week from predictions made in December.

Stocks are down around 15% from a year ago1. And the euro keeps going up in value against the pound, which can only be annoying for an economy that is trying its hardest to compete on cheap exports.

The guys charged with overseeing the economy are taking more and more drastic measures. Last Thursday, they announced their latest.

Read more: Five reasons European markets could beat the US in 2016

Five key things to know:

  1. The eurozone's main interest rate, which has been negative for some time now, was further cut to -0.4%. The goal of cutting interest rates is to stimulate economic growth by encouraging banks to lend and making it cheaper for people and businesses to borrow – which should free up disposable income, boost consumer confidence and spending, and encourage companies to start new projects and hire new people.

  2. The problem is, you can have too much of a 'good thing'. At some point, the banks run into strife. If you're paying less on your loans, they're making less money. You may think who cares?!, but if banks can no longer lend profitably, they stop. And the money flowing into the economy grinds to a halt, along with any chances of economic growth.

  3. So the eurozone wants to have its cake and eat it too. Can it? Along with the rate cuts on Thursday, it introduced a way for the commercial banks (the ones that lend to the people and the businesses) to also borrow at rates that can be as low as -0.4%. Basically, the European Central Bank (the über bank that sets all these policies) is going to ensure banks get a bad deal if they hang on to their money and a good one if they lend it out.

  4. That's not the only party trick. The European Central Bank buys government bonds every month as another way of pumping money into the economy. It now says it's going to start buying more and, for the first time, it's going to buy company bonds too. These are a riskier investment. If the central bank is willing to take this step, it tells us the eurozone really does need a lot more help to get going.

  5. All of this can, and hopefully will, have a positive impact. In the short-term, though, the words of one Mr Mario Draghi, the European Central Bank president, are having the greatest effect. Investors focus on the future and Draghi is the oracle. On Thursday afternoon he caused stock markets to fall, after an initial bounce, simply by suggesting he wouldn't lower rates again (low rates typically support stock market growth). On Friday, markets regained some equilibrium as investors processed the extent of his other measures. Only time will tell if they produce the desired economic effect, but we can expect plenty more sensationalist headlines along the way – sadly though, falling short of the Kardashian flair.

Keep reading:

1Euro Stoxx 50 index, 16/03/2015-14/03/2016, Google Finance, accessed 14/03/2016

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Sam's views are her own and do not constitute financial advice.


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