Nick Parsons, National Australia Bank believes that with the 25 bps rate cut equities will not rally. According to him the European Central Bank (ECB)might copy the Bank of England‘s approach and have a more targeted lending program aimed at Small and Medium-sized Enterprise (SME).
Nick Parsons of National Australia Bank believes that a 25 bps rate cut by the European Central Bank (ECB) will not neccessarily result in a rally in equity markets.
According to him the ECB might copy the Bank of England’s approach and have a more targeted lending programme aimed at Small and Medium-sized Enterprise (SME).
However, Parson believes a 25 bps cut could be a chance for EM to play a bit of a catch up, as the S&P is only 1 percent away from its peak, whereas EM is about 8 percent.
Below is the verbatim transcript of his interview to CNBC-TV18
Q: What is the mood like over there ahead of the European Central Bank (ECB) rate decision and if we do get a 25 bps cut what would be the market reaction? How much is already priced in?
A: A very great deal is priced in as far as the ECB is concerned. Draghi’s one hallmark through his tenure so far has been pre-emptive. He likes to appear ahead of the data and show he is decisive. He likes to show that ECB is indeed in control.
So, rather than wait for June’s new staff forecasts on the economy it is very likely that he is going to cut interest rates today. He is going to seize the bull by the horns in response to weaker inflation numbers and lower output numbers across Europe. However, most recently and especially in the core then we are going to see a rate cut today.
Q: What will be the impact? Is it largely priced in?
A: It is going to be reassuring to the extent that we are still seeing an ECB which is trying to pull policy levers. That is good news, however in current environment we have a situation where businesses, individuals and households do not want to borrow money at any price. If you do not want to borrow money at any price it is really difficult to see that changing the price is going to have much of an impact.
If people did not want to borrow at 0.75 percent then 25 bps extra is neither here nor there. So, partly it is reassuring that there is some action, but in terms of real activity and business and corporate profitability it is going to have very little impact at all. As long as capacity utilisation remains very subdued you have to ask yourself why businesses would be seeking to invest. Therefore, why would a cut in interest rates make much difference?
Q: Any other measures expected from the ECB and what is the current expectations in terms of commentary?
A: It is just possible. It is still an outside chance that they might copy the Bank of England’s approach and have a more targeted lending programme aimed at Small and Medium-sized Enterprise (SME). The problem though is that this takes a lot of proprietary work. The Bank of England had been working on its own scheme since the summer of last year before it was introduced in December.
It is not clear that the European banking system is quite ready for that, but as I mentioned the key thing is the lack of demand. I guess to the extent that Draghi may say that they are trying to work on that it might at least reassure people that the ECB is not sitting idly by as the economy shrinks and the recession deepens.
Q: How do you expect equity markets to react hereon? We have seen them ignore growth data significantly. Do you think that rally continues simply because there is so much liquidity?
A: I am thinking that it maybe chance for EM to play a bit of a catch up more generally. If we look the S&P 500 made fresh high earlier this week. European markets have recovered quite well. They are all up year-to-date (YTD). If we look across EM it is still about 7 or 8 percent lower than the peak.
I know the Indian markets had an exceptionally good run over the course of the last 10 days. However, more broadly, in EM world I think there is scope for a catch up here whereas the S&P is only 1 percent away from its peak EM is about 8 percent.
It could just be that where people start to look at what they perceive to be value we might just get a bit of catch up coming through here.
Q: If you do get a 25 bps rate cut will the equities rally according to you at least in the near-term?
A: I do not think we are going to see a strong equity rally until all this week’s hurdles is cleared. Of course we are taking them off one by one. We have got Purchasing Managers' Index (PMI) surveys, Institute of Supply Management (ISM) surveys, central bank last night in the US, central bank in Europe today and then of course we have got the payroll report tomorrow.
So, I do not think we are necessarily going to see a one day rally on whatever the ECB does or does not do today. I do think that when we get into next week there is a chance that we could get a more rounded view of it. We could see investors deciding that, for lack of alternatives equities are still the place to be. Of course we have got so many hurdles in our path this week that today is not the last of them. So, we really need to clear the payroll hurdle as well.
Q: We have had a 1 percent rally over end Tuesday and today morning because of withholding Tax on foreign investments in Indian paper getting cut from 20 percent to 5 percent. That rally perhaps has also been fuelled by the stock market rally. What is your sense of where the rupee is headed?
A: The rupee has got scope to strengthen further. Let us remind ourselves that at the start of the year we are at 54.6, here we are today at 53.75. So, not only have you made 2 percent gain just by being long of the currency, but you are also getting paid to play it.
So, any currency that has got the sort of running yield that the rupee has alongside those regulatory changes that you mentioned and against the background where investors are not generally even at benchmark weightings in the currency, let alone overweight there is scope for it to move further. At the end of February we were at 53.60. There is no reason why we cannot be trading below 53.50 over the course of this month at some point.