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What's going on?
The European Central Bank (ECB) met on Thursday and its President, Mario Draghi, made very clear that it stands ready to provide more stimulus to the economy if necessary. Stocks in Europe rose about 2% and US stocks also finished the day higher.
What does this mean?
As we mentioned yesterday, the recent market turmoil has made it more likely that central banks will do things that help stimulate the economy. In the US, this could mean holding off increasing interest rates for the foreseeable future. In Europe, it might mean increasing the supportive measures which are in place already (e.g. buying more government bonds). Such actions help not just the economy but also, typically, the price of stocks and bonds. Thats partly because low interest rates help convince investors to buy riskier things, like stocks and junk bonds, rather than safe government bonds that pay them virtually no interest.
Why should I care?
For the markets: Central bank actions, arguably, lose their potency with each new action. In a very basic way, its like caffeine. Someone who never drinks coffee gets a huge buzz from one cup. But for someone who drinks 4 a day, the effect is much less and even the cumulative effect of all 4 cups is probably less than someone who has one only once in a blue moon (heres a much more complicated description from worlds biggest hedge fund manager. The point is that investors are starting to question how effective central banks can be right now given how much stimulus theyve already done in the past.
The bigger picture: Lack of inflation remains a concern. The ECB has an explicit mandate to maintain price stability, which they interpret to mean annual inflation of close to, but below, 2%. With the oil price collapse, its looking increasingly unlikely that inflation will increase much, if at all, in 2016. Since buying government bonds is thought to help encourage inflation (for an explanation see our previous story), its another reason why the ECB is likely to consider increasing the amount of bonds that it purchases.
Originally posted as part of the Finimize daily email.
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