Equity markets continue to hold steady but for the time being at least struggle to push on. The latest pieces of Chinese economic data reassured investors that the economy may hold the 7.5% growth target as imports and exports exceeded expectations; export data in particular boosted by a strong contribution from the US. Overnight on Monday Chinese inflation came in at 2.5%, slightly higher than the anticipated 1.8%. The moderately higher inflation figure did not prevent China’s central bank announcing a half percent cut in the reserve rate ratio (RRR). Cutting the RRR increases a country’s money supply as it reduces the portion of depositors’ balances a bank must have on hand in cash.
Tuesday was the day when the yield on the Spanish 10-year bond fell below that of its US treasury counterpart. The yield on the Spanish 10-year bond is now 2.58%. The yield on the Italian 5-year bond has also fallen below that of its US equivalent. The fall in Spanish bond yields now means that the dividend yield on the index of the 50 largest companies in Europe (Eurostoxx 50) is the same as the yield on the 10-year Spanish bond, making the European equity markets look that much more attractive.
Mr. Draghi and his fellow council members may have concluded that by introducing negative deposit rates for banks, the banks would remove the money on deposit with the ECB and invest it back into the bond market forcing yields even lower. Those investors who had been invested in peripheral bonds would look for better returns elsewhere as yields fall; the obvious place is the equity market. Just as QE in America had the initial impact of reflating equity prices hoping other asset classes would follow, the ECB may at last be trying the same trick. As the S&P 500 continues to trade at all time highs, the Eurostoxx 50 closed on Tuesday at 3315 substantially below its high in 2007 of 4500. Time will tell if Mr. Draghi’s measures have the same impact as Mr. Bernanke’s.
The economic good news continued in the UK today as the Office for National Statistics reported that industrial output grew at its fastest annual pace for 3 years in April. This data encourages the view that the UK economic recovery is becoming broader based and not just housing recovery led.