Emma Wall: Hello, and welcome to the Morningstar series, "Market Reaction." I'm Emma Wall and I'm joined today by Vanguard's Alexis Gray to talk about central bank policy in Europe.
Hello, Alexis.
Alexis Gray: Hi.
Wall: So, yesterday we had the ECB meeting and it wasn't a surprise that the ECB decided to hold rates and not make any decisions about QE. But one of the things they did talk about, they did flag, was the euro. Why is the ECB concerned about the euro?
Gray: The reason that the ECB is concerned about the euro is that it's being gradually strengthening against a basket of other currencies, including the US dollar this year. And typically, when a currency strengthens quite a bit, that can dampen inflation. We know that the ECB is being worried for a while that inflation is not picking up as much as they would hope. It's not getting back to target. And then the other thing, of course, is that a stronger currency may weigh on exports. So, I guess, it's on both sides for growth and inflation that they would mention that the euro strength may be sort of holding back a little bit some of that inflation and growth recovery.
Wall: And they did give some foresight into what we should expect come October's meeting, didn't they?
Gray: That's right. So, I think, at this meeting there was a possibility that we would get an announcement about QE beyond this year. So, they have already committed to buying 60 billion worth of bonds up until December. But on balance, they decided to wait one more meeting. So, it seems quite likely that the ECB will announce next month that they are going to taper asset purchases and that means perhaps cutting from 60 billion to 40 billion per month. And that makes sense. The recovery is going well. The unemployment rate is falling. So, there is no need for this sort of emergency stimulus at such a high level.
Wall: And that foresight is critical because markets hate uncertainty. We saw a few years ago the taper tantrum where markets weren't ready for the US to stop doing QE and when they hinted that they might, certain currencies went into free fall. So, with this in mind, that investors know this may well be coming, what is the impact for markets and investors?
Gray: Well, I think that Draghi has done a good job. I mean, definitely, you see the ECB taking lessons from what happened with the Fed. Bernanke announced quite early the intention to taper and that sent markets into a spin. That was few years ago. So, he has been much more cautious with his language, right? So, I think that the market is much more prepared, mentally prepared for what's to come and I don't think the reaction will be as strong unless, of course, we get something really surprising. But I don't think that's going to happen.
Wall: And what about its impact on bond markets, because of course it has been propping up both government and corporate bonds in Europe?
Gray: That's true. I think recently you've seen the markets thinking about this possibility of tapering, but still having, I'd say, pretty healthy levels in the bond market. Bond markets have been performing quite well. When you think about the backdrop, why is the ECB going to taper, because the economy is strong, right? And that's the best environment that you would go into a tapering.
Wall: Thank you very much, Alexis.
Gray: You're welcome.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
