During the press conference, Draghi gave an indication of how he would like the ECB’s balance sheet to grow. He stated that it would be desirable for the balance sheet to reach its 2012 levels, which would imply an expansion of more than €1 trillion. To provide some perspective, the peak of the ECB’s balance sheet size stood at €3.1 trillion in June 2012, where else the balance sheet size today stands at only €2.0 trillion2.
An expanding balance sheet has traditionally led to a weaker local currency, in this case the euro. Draghi has previously talked about the euro’s strength as it approached the 1.40 level in May this year. We discussed his comments in a previous blog. His rhetoric about a rising euro potentially creating deflationary pressures was quite effective as the currency depreciated from 1.403 to just about 1.30 following this latest news. But now Draghi is backing up his words with concrete actions to expand the ECB balance sheet—measures that have been associated with currency weakness.
The weakness in the euro does not mean the case for investing in Europe should be weakened. Stocks reacted quite positively to the news of these additional measures. The weakness in the euro just highlights the need to adopt currency-hedged equity strategies in obtaining exposure to European stocks.
1Mario Draghi, “Introductory statement to the press conference,” European Central Bank, 9/4/14.
2Sources: ECB, Bloomberg as of August 2014.
31.40: refers to the spot exchange rate of the eur currency vs. the usd.
Important Risks Related to this Article
Investments focused in Europe are increasing the impact of events and developments associated with the region, which can adversely affect performance. Investments in currency involve additional special risks, such as credit risk and interest rate fluctuations.