It looks like 2014 is shaping up to be the year of euro-hedged European equities. This is, in part, thanks to European Central Bank (ECB) president Mario Draghi.

His recent comments discussing a strengthening euro as a key contributor to disinflation— or declining levels of inflation—suggest that he’s committed to preventing the euro from further appreciation. In many ways, he’s already been successful, as the euro has trended down from $1.39 to $1.36 on June 5, the day of his latest policy measure announcements.1

But Draghi has taken a step beyond rhetoric and is taking measures designed to support inflation and the European economy in a number of targeted ways. He detailed the unanimous decision of the ECB’s Governing Council to provide a package of monetary easing programs designed to confront low levels of inflation.

Key elements include:

1) Cutting three key interest rates while extending the ECB’s forward interest rate guidance (or the outlook for keeping low interest rates for a longer period) including a cut in the ECB’s deposit rate that puts it in negative territory. Effectively, this means banks will have to pay to keep money on deposit at the ECB—which may encourage more lending.

2) The announcement of €400 billion in targeted long-term financing for banks to support lending to corporations, which is intended to counterbalance the de-leveraging that banks are engaging in so that they can pass stress tests on their loan portfolios.

3) Suspension of the liquidity sterilization of the Securities Markets Program, which, in simple terms may lead to an expansion of the ECB balance sheet, and which is generally thought to support a weaker euro.

One critical transmission mechanism of these policies, bank lending to many small and medium-size enterprises, has been constrained, especially in the peripheral European markets. A key part of this new financing package is that the ECB’s extension of loans does not support housing markets or the sovereign debt markets—which Draghi alluded to as having “bubblish” characteristics.2

Draghi’s targeted long-term funding operations—which come at a fixed, low rate of interest—should support net new lending to corporations. This package is intended to lower the cost of funds for European businesses; more generally, it is intended to support the budding economic recovery for businesses.

Another area Draghi is avoiding is lending for mortgage purchases, which is a sign that he is distinguishing himself from programs in the United Kingdom that many think are leading to very high home prices.3

Implications for Equity Investors

When asked about future measures, Draghi said, “We aren’t finished here.” This implies that there is more to come, and it echoes his statement in June 2012 that the ECB would do “whatever it takes” to save the euro during the crisis—a statement that was a key to the rebound in sentiment for the euro in late 2012 and 2013.

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