The European Central Bank cut interest rates to their lowest level ever yesterday. The 25 basis points cut (that’s a quarter of a percentage point) took the rate down to 0.75%. The ECB also cut its marginal lending and deposit rates to 1.5% and 0% respectively.
The idea here is that this will encourage banks to lend. Analysts – and the markets – were sceptical. Spanish bond yields shot up again, and markets fell, undoing a big chunk of the gains seen since the summit-inspired rally.
And little wonder. After years of inaction following the credit crisis, Europe’s banks remain the most bankrupt in the world. If banks in the UK and the US are still having trouble making loans, you can forget about their eurozone peers suddenly pumping out cash.
In short, this isn’t going to work. Sooner or later, if it doesn’t want to see the eurozone collapse entirely, the ECB is going to be pushed to follow the Bank of England and the Federal Reserve into printing money.
The ECB will have to print money eventually
Here’s the problem. The latest data shows that eurozone M3, the broadest monetary measure, is growing at only 2.5%. This is well below the level need for strong growth.
While increased bank lending would boost this, this is unlikely to happen. The need to raise more capital, and the ongoing fears over Spanish and Italian debt, aren’t suddenly going to vanish because the ECB is offering 33bps less on deposits.
In any case, even if banks were happy to lend, there simply isn’t the demand in the wider economy for credit. Even Brussels expects the eurozone to slip back into recession.
So despite last week’s deal, the sovereign debt crisis continues. Supporting the banks directly via the eurozone bail-out fund (the EFSF), rather than national governments, is clearly good news for the Spanish, Italians and Greeks. It is also good news for Dublin if it is allowed to retrospectively take part.
However, it is vital to remember that the burden of the bail-outs has now simply been spread among all national governments, not eliminated. And they haven’t yet all agreed to commit wholeheartedly to this move.
The idea has led to anger in countries such as Germany and Finland. Indeed, Chancellor Angela Merkel has also been told by the leader of her sister party that any further concessions will destroy her coalition.
Meanwhile, even if the eurozone can agree to recapitalise its banking system between itself, that won’t solve the money supply problem. Remember – Britain and the US have been able to bypass all this arguing that the Europeans have been stuck with. Yet they’ve still needed to print money simply to offset the deflationary impact of the banking crisis (MoneyWeek regular James Ferguson explains the situation well here.)
The fact remains that boosting the money supply through quantitative easing (QE) is the only way to get the economy growing faster than debt. It might take a few more crises to reach that point, but on balance, if faced with the choice between eurozone meltdown or taking the leash off the ECB, we reckon they’ll end up opting for the latter.
This Italian stock looks good value
So how should you play a bout of money printing by the ECB? The euro has already plunged following yesterday’s rate cut. But money printing would weaken it even further.
Nancy Curtin, the chief investment officer of Close Brothers Asset Management, has some suggestions for ways to profit. While she is not a fan of European firms that rely on domestic demand, she likes those that sell abroad. Their external focus makes them less vulnerable to the ongoing downturn. More importantly, a weaker euro will also make exports a lot more competitive.
One such firm is the Italian tyre manufacturer Pirelli (MI: PC). Although it employs a large number of staff in Europe, nearly two-thirds of its sales are outside the EU. Sales in the first quarter saw double-digit growth in North America, the Middle East and Asia, compared with the same time last year.
Although expectations are more modest for other regions, the tyre company is still expected to do well everywhere other than Europe. It recently increased its investment in Mexico, which should help access to the NAFTA (North American Free Trade Agreement) region.
Despite all these advantages, it is still very cheap: it currently trades at less than nine times trailing earnings, and 7.5 times expected profits. In contrast, rivals Bridgestone (BE: BGT) and Goodyear (NYSE:GT) have price/earning ratios of 12.7 and 13.6 respectively.
Also, at the most recent roundtable, our experts tipped a couple of other Italian manufacturers that should continue to do well even amid the eurozone chaos. (If you’re not already a subscriber, subscribe to MoneyWeek magazine.)