We’ve seen this play before: Financial markets start to tumble and central banks step in–not with actual stimulus quite yet but certainly with talk of stimulus.
The European Central Bank and the German government took a turn today. Germany’s Der Spiegel magazine reported today that Chancellor Angela Merkel and Finance Minister Olaf Scholz would be willing to increase the budget deficit to avoid an economic slump. Under the German constitution net government debt can increase by only 0.35% of output if there is positive GDP growth. But during a recession, the rules get relaxed and the budget deficit can climb beyond that limit. The German economy contracted in the second quarter; another down quarter would push it into recession and pave the way to more budgetary stimulus.
The implications here extend beyond Germany to the entire EuroZone economy. If Germany, the foremost voice at the central bank for tighter fiscal and monetary policy, is on board for more stimulus, then the European Central Bank is more likely to act as well.
Last month European Central Bank President Mario Draghi raised the prospect of more stimulus from the bank in September. Put that comment together with the article in Der Spiegel and then add in comments yesterday from Olli Rehn, the head of Finland’s central bank and a member of the rate-setting committee at the European Central Bank and you’ve got real prospects for a substantial package from the bank in September.
Perhaps very substantial.
Before Rehn’s comments analysts were thinking that in September the European Central Bank would announce a 0.1 percentage point cut in the current negative 0.4% benchmark interest rate and something like a new $50 billion euros ($56 billion) a month round of bond purchases. That would reinstate a program of quantitative easing that the bank phased out at the end of last year.
After Rehn’s comments, expectations have moved upwards to include a 0.2 percentage point cut and the start of purchases of a new category of assets.
No wonder that the Stoxx Europe 600 Index rose 1.2% today. Or that the euro was higher for much of the day before finishing down 0.1% at $1.1092.
The U.S. markets rode this European enthusiasm to a gain of 1.44% in the Standard & Poor’s 500 and 1.20% in the Dow Jones Industrial Average. The NASDAQ Composite climbed 1.67% and the Russell 2000 small cap index gained 2.19%.
The central bank news from Europe is also a reminder that Fed chair Jerome Powell is scheduled for major remarks on August 23–next Friday–at the Fed’s annual central bankers retreat in Jackson Hole, Wyoming. Today the market seemed to be thinking that Powell would signal more rate cuts (plural) from the Fed.
All this talk now from central banks would be followed by bigger than expected stimulus packages in September.
Or at least that’s the market’s belief today.