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European Central Bank boss Mario Draghi is widely viewed as the man who saved the eurozone.
With the magic words, “whatever it takes”, Draghi managed to put an end to the eurozone panic in summer 2012.
Since then, via some clever politicking and a real talent for leading markets by the nose, Draghi – more than any individual politician, which goes a long way to indicating why the population at large feels disconnected from the true seats of power in the modern economy – has managed to keep the show on the road.
But now he’s stepping down, at a time when continental European growth is looking more fragile than at any point since he uttered those magic words.
So how will he secure his legacy?
Presumably by doing “whatever it takes”.
All eyes on Mario Draghi
On Thursday, all eyes will be on the next monetary policy announcement from the European Central Bank (ECB).
This is a big one. It’s Mario Draghi’s second-last meeting before he hands over to Christine Lagarde. And it’s also coming at a time when fear of deflation in the region is higher than it’s ever been (judging by bond yields, at least).
So investors want to see how Draghi can arrest the rot this time. That means expectations are high.
As it stands, markets expect the ECB to cut rates further into negative territory. That pretty much goes without saying. But what they want to see, too, is more money-printing (eurozone quantitative easing). And not just more now – they want to see a promise that the ECB will keep doing it.
One big thing to watch is for a move in the limits of what the ECB can buy. Right now, the ECB is not supposed to own any more than 33% of a country’s bond market. But it’s bumping up against those restrictions which makes it hard to do more. So if Draghi gets his way, then expect that limit to go up to 50% at least.
Recently, markets have grown a little more concerned because the “hawkish” members of the ECB have been piping up to say that money printing and the rest of it isn’t necessarily a good idea.
However, this is in keeping with Draghi’s historic tactic of keeping the market on its toes, so that whatever he ends up doing has maximum impact. So I suspect that any objections are cosmetic – what Draghi wants, he will probably get, at least on this occasion.
Can Draghi actually fix it?
The question then is: what difference does any of this make?
From an investor’s point of view, it’s tricky. Clearly if Draghi can convince the markets that he’s done enough (and he has the most consistent history of pulling rabbits out of hats of any official of his generation), then it implies a rebound in European stocks and particularly the troubled banking sector.
But what would be enough? The biggest risk for the eurozone right now is that nothing anyone has done appears to be helping, and doing more of the same risks revealing that no one has any new ideas.
A Japan-style financial future beckons. Except that the eurozone would struggle to survive politically against that sort of backdrop, because it’s not a homogenous society, it’s a group of at least nominally sovereign states whose populations will look for alternatives if conditions gets too painful.
So what I’m most interested to see, and what I think could make a real difference – at least in terms of convincing markets that something big has changed – is if the ECB somehow addresses the effect of negative interest rates on banks. At the moment, one of the eurozone’s significant problems is its banking sector.
As the Financial Times points out, “banks are the main source of finance for European companies and households”. As a result, they are a key “transmission mechanism” for monetary policy. In other words, if the ECB wants cheaper monetary policy to translate into more economic activity, it needs the banks to be making cheap loans.
(The US is different in that the corporate bond market – companies going direct to investors – is much more developed.)
The trouble is, if you cut rates into negative territory, it becomes difficult for banks to lend and to make money.
But the fact that the ECB has said that it is actively discussing the potential ill-effects of negative interest rates at this meeting suggests to me that this might be an opportunity to come up with some cunning plan to address the situation.
I genuinely can’t currently think what that would be. Tiered interest rates is one option which has been tried elsewhere; direct lending is another. But until we see what happens, it’s all just speculation.
The nice thing, of course, is that unless you’re a day trader (and if you are, I recommend you stop now because the odds are high that it’ll ruin you one way or other), then you don’t have to act until we see what happens on Thursday.
If Draghi really can work out a way to put the eurozone banking sector on a more profitable footing for anything beyond the next six months, then there will be plenty of time to buy in.
And if he can’t, well, we’ll probably reach another crisis point that forces the issue one way or another, but you can patiently wait for that one.
Financial historian and analyst Russell Napier writes a great deal on this (and he’s very gloomy on prospects for the euro). You’ll be able to find out more about Russell’s current views at the MoneyWeek Wealth Summit on 22 November in London, when he’ll be sharing his thoughts on the investment environment with us. He’s just one of several fantastic speakers we’ve got lined up – book your ticket now.