Why the Dow's European Central Bank Boost Didn't Last Long

Investors in the Dow Jones Industrials were waiting for Europe's central bank to make its policy move, but the gains disappeared quickly.

Jun 5, 2014 at 11:00AM
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The Dow Jones Industrials (DJINDICES:^DJI) have been volatile in early trading Thursday, rising about 24 points as of 11 a.m. EDT. Initially, the Dow rose in line with the U.K.'s FTSE 100 (FTSEINDICES:^FTSE) and Germany's Dax (DAXINDICES:^DAX) after the European Central Bank detailed long-awaited changes to monetary policy with some unprecedented moves to stimulate the continent's economy. Yet European stock markets quickly gave back their knee-jerk gains, and the Dow actually traded down briefly as investors questioned whether the ECB's decision will have a marked long-term impact.

Euro

What the ECB did
The European Central Bank and its president, Mario Draghi, have signaled for months that they stood ready to help the sluggish recovery in Europe's economy become stronger. Nevertheless, only today did the ECB begin using some of the more aggressive tools at its disposal to try to jump-start the European economy. Specifically, the ECB cut its refinancing interest rate from 0.25% to 0.15%, an all-time low. It also implemented measures to encourage banks to make more loans available to customers by offering cheap rates.

Yet the most psychologically important move was the ECB's decision to push its deposit rate down into negative territory at -0.1%, essentially charging the banks that deposit money with the central bank for the right to keep their funds safe. No major central bank has done that before, and policymakers clearly hope that penalizing banks for keeping money on deposit will drive those institutions to find alternative ways to put cash to use that could encourage greater levels of economic activity.

Other central banks have also taken steps to support economic growth. The Bank of England left its key interest rate at 0.5%, despite the fact that the U.K. economy has been performing relatively well and even though a strong housing market has raised fears of excessive speculation and a possible real-estate bubble. Clearly, worries about Europe's economic strength go beyond the formal eurozone.

What's left for the ECB to do
One thing that the ECB didn't do was adopt a policy of making asset purchases, similar to what the Federal Reserve did with quantitative easing. That reluctance to go full-throttle on stimulus might be behind the lackluster reaction from European stock markets and from the Dow, and it reflects to some extent the structural differences between the Fed's national scope and the ECB's multinational coverage area. To implement quantitative easing, the ECB would have to buy bonds from various countries in a way that didn't upset national bond markets or play favorites among its member states. Still, Draghi said that preparatory work has begun on surmounting those challenges, and the good news for European investors is that the ECB still has bullets remaining in its arsenal for potential use in the future.

Economic stimulus has pushed the Dow Jones Industrials and other stock markets higher in the past, but today's announcement makes it clear that there's a limit to the effectiveness of central-bank intervention. What happens with the ECB and Europe in the coming months will continue to have a big impact on the global economy and the Dow.

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