• Dec. 4, 2016, 8:14 am

Draghi has financial markets hoping bad news is really good news

Powered by Guardian.co.ukThis article titled “Draghi has financial markets hoping bad news is really good news” was written by Larry Elliott Economics editor, for theguardian.com on Monday 15th February 2016 18.12 UTC

Japan’s growth figures were bad. The data for Chinese exports was even worse. A signal for the financial markets to have another dose of the heebie-jeebies? Not a bit of it. This was one of those days when bad news was good news.

The thinking goes as follows. If the Japanese economy shrank by 0.4% in the final three months of 2015 and Chinese exports fell by more than 11%, policymakers will sit up and take notice. Central banks will stimulate activity by cutting interest rates, even when they are already negative, and by expanding their quantitative easing (QE) programmes.

Right on cue, Mario Draghi popped up before the European parliament to administer a bit of his own soothing balm. Yes, of course, the European Central Bank (ECB) is abreast of what has been going on in the markets, and “will not hesitate to act” if necessary.

Markets took this as a promise from the ECB president that he will come up with more stimulus next month. More stimulus equals more growth equals higher corporate profits equals higher share prices.

A moment’s thought suggests this is a far from watertight thesis. For a start, financial markets should wait and see what Draghi does rather than get too excited about what he says. The ECB disappointed in December by not delivering as much extra stimulus as expected, in large part because Draghi ran into resistance from Germany.

Even if the ECB does come up with the goods and this is accompanied by more action from the Bank of Japan and the People’s Bank of China, there is no guarantee that it will have any material effect. There has been no shortage of action from central banks these past seven years and, let’s be honest, the outcome has been disappointing.

Andrew Lapthorne, analyst at Société Générale, notes that one of the ploys being used by central banks – negative interest rates– is subject to the law of unintended consequences. Negative interest rates make holding government bonds attractive even when they are yielding next to nothing. Yet one of the rationales for QE is that it discourages investors from holding government bonds and encourages them to dabble in riskier assets.

All this prompts the conclusion that bad economic news really is bad news. In the current climate, there are really only two groups of people. Those who admit they don’t really have a clue what’s going on and those that don’t have a clue but pretend that they do. Central banks fall into the latter category.

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