Market Commentary: ECB still battling low inflation one year after recession

Markets opened higher this morning after China's manufacturing activity expanded for the first time in six months in June, adding to evidence the world's second-biggest economy is stabilizing.

A flash reading of the HSBC/Markit purchasing managers' index (PMI) rose to 50.8 versus the 49.4 final reading in May, above the 50-level that demarcates expansion from contraction.

In Europe, Mario Draghi indicated that the European Central Bank’s interest rates will probably remain low or at least another 2.5 years. A year after the euro area exited its longest recession, the ECB is still battling too-low inflation and attempting to reboot demand.

Draghi introduced an unprecedented range of measures this month including a negative deposit rate and said quantitative easing remains an option if deflation appears.    

While investors are looking now for hints from the U.S. Federal Reserve and the Bank of England on when their cost of borrowing will begin to rise, Draghi said that the euro-area recovery is at “an earlier stage” than that of its peers and that broad-based asset purchases would be “the answer” if the inflation outlook weakens further.

Most European banks are confident they won’t need to raise capital after the European Central Bank’s balance-sheet review, a study by Ernst & Young LLP showed. Only 22 of the 294 institutions surveyed for E&Y’s twice-yearly European Banking Barometer say they will need to raise capital following the ECB’s assessment, with a further 43 saying they might have to.

While about two-thirds of the banks are optimistic about the economic outlook and their own performance, one in three says it will increase provisions against loan losses in the next six months.

In corporate news, BNP Paribas SA is close to an agreement to plead guilty and pay $8 billion to $9 billion to settle allegations it violated U.S. sanctions. The French bank intentionally hid transactions amounting to about $30 billion that violated U.S. sanctions against countries including Iran and Sudan. BNP Paribas will probably plead guilty in early July to a criminal charge of conspiring to violate the International Emergency Economic Powers Act.

Companies in the Topix index are acquiring their own stock at the fastest pace ever, led by NTT Docomo Inc. and Toyota Motor Corp., with $25 billion of announced purchases so far this year, data compiled by Bloomberg show. The buybacks are limiting losses in the world’s worst-performing developed equity market: Companies using the strategy have gained even as the Topix slid.

The combination of record cash, cheap shares and a government-led drive to buoy return on equity is making buybacks irresistible to Japanese executives at a time when the MSCI All-Country World Index is trading at unprecedented highs.
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