Losses in European banks, concerns over a potential Brexit and the refugee crisis have been under the spotlight in the eurozone for months, depressing investor sentiment and weighing on the performance of European stock markets.
European Central Bank governor Mario Draghi released another round of quantitative easing measures on March 10, which are expected to support economic recovery in the region.
We believe the economic outlook in the eurozone is basically positive.
Eurozone countries such as Germany, France, Italy and Spain saw a slight slowdown in their leading economic indicators such as the purchasing managers index.
On the other hand, consumer confidence is at a high level, supported by low interest rates and weak oil prices. The unemployment rate is also declining.
All these factors will support consumption and non-essential expenses in Europe.
To maintain the momentum of economic recovery, Draghi has extended the use of monetary policy such as by 1) cutting the policy rate (the deposit rate is currently at negative 0.4 percent now); 2) expanding the asset purchasing plan to 80 billion euros (US$90 billion) from 60 billion euros; 3) making euro-denominated, investment-grade corporate bonds issued by non-banking institutions eligible under the asset purchasing plans; and 4) unveiling a new series of four targeted, longer-term refinancing operations (TLTRO II), which will last for four years.
Meanwhile, European banks reported very disappointing earnings in the fourth quarter last year while the Additional Tier 1 bond market saw selloffs, resulting in a stressful financial situation for the lenders.
European banks’ shares slumped and the interest spread of credit default swaps for European financial institutions has soared.
We expect European banks to face a more challenging environment.
Because the global financial markets remain volatile and the overall economic growth is weak, the capital market is likely to be less active.
Moreover, the quantitative easing measures and the negative interest rate policy will narrow the net interest margin of banks, while the changing regulatory environment, along with the attached costs, will cause uncertainties.
Overall, with the recovery of the European economy and the regulators’ determination to stabilize the banking industry, I see a brighter outlook for domestic European consumption businesses than the European exporters.
Amid the negative interest rate environment, I believe companies that offer high dividend payout ratio or dividend growth can provide better returns.
This article appeared in the Hong Kong Economic Journal on April 25.
Translation by Myssie You
[Chinese version 中文版]
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