International Equity Commentary – August 2014

European Stimulus Expectations Help Offset Geopolitical Risks

International equity prices saw modest gains in August as expectations about expanded monetary stimulus from the European Central Bank (ECB) largely offset persistent geopolitical tensions in Ukraine and the Middle East. Economic signals from the Euro-zone deteriorated further and inflation slipped again. Most major economies in the region saw weaker economic activity during the second quarter, including Germany that had been the growth engine for the region in recent years. In response, the ECB lowered its benchmark rate and has announced plans to start purchasing asset-backed securities in the near future. Meanwhile, U.S. Federal Reserve officials tried to allay market fears of an early rate hike by suggesting that the country’s labor market has not recovered enough to withstand higher interest rates.

The Japanese economy contracted more than expected during the second quarter on lower consumer spending after taxes were increased in April. In the U.K., GDP growth continued to exceed expectations during the second quarter and the country is likely to see the fastest growth among major developed economies this year. Among the emerging markets, India saw faster growth during the April – June quarter while output growth remained weak in Brazil. Global manufacturing and services activity continued to expand in August, helped by gains in the U.S. and the U.K. China’s manufacturing output growth was softer during the month, but the services sector saw acceleration.

Near-Term Outlook

The ECB’s marginal interest rate cut and asset purchase program announcement were largely unexpected, and have been well received by the markets. However, by delaying quantitative easing this long, there are concerns that the ECB has possibly made it less effective. The Euro-zone economy has been in a recession for a while now, and it is uncertain if additional monetary stimulus measures can make a significant contribution to reviving growth. The negative deposit rates are likely to encourage banks to step up lending to consumers and businesses. Nevertheless, the bond purchase program as announced is limited to select assets. As such, the scale of the program as proposed could be restricted by the availability of qualified assets. If economic growth remains subdued and deflationary risks worsen, it is likely that the ECB could expand the program further in the future. In any case, the recent decline of the Euro against other currencies in anticipation of ECB action could help exporters in the region to regain some of their price competitiveness.

The larger than expected decline of the Japanese economy in the second quarter has yet again revived concerns about the success of reform measures collectively known as ‘Abenomics.’ Consumer and business sentiment surveys suggested a recovery in May and June, but the trends have become less positive in August. The government announced its long anticipated fiscal reform measures recently, but they need to be implemented without further delay. On the positive side, exports picked up in July after the weak trends during the previous two months. The ongoing revival in global demand and the yen’s recent decline should help Japanese exports in the coming months. The Bank of Japan is yet to scale up its monetary stimulus measures, as the bank remains confident of meeting its inflation targets next year.

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