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Market News The European Central Bank's interest rate decision is imminent, gold bulls should not take it lightly

The European Central Bank's interest rate decision is imminent, gold bulls should not take it lightly

High inflation in Europe in recent months has raised questions about when the European Central Bank will begin to tighten monetary policy. Although the central bank's shift to raising interest rates and reducing the scale of bond purchases may bring resistance to gold investment in the region, the World Gold Council believes that the pace of policy changes will not accelerate because there are still some risks.

LEO
2021-09-07
9181

The World Gold Association issued a report stating that the association expects that gold will remain a key strategic asset for European investors. Due to long-term negative interest rates, structural changes in the asset allocation of European investors have begun to take effect, which is good for gold. Second, investors need to formulate hedging strategies to manage the subsequent impact of the anti-epidemic fiscal policy. Finally, the long-term effects of European policies, including rising inflation, rising deficits and potential asset bubbles, may ultimately affect global gold trends.



The epidemic triggered two types of demand, and European gold investment soared to a record high


European investors are no strangers to investing in gold, especially in times of crisis. For example, the global financial crisis (GFC) has led to a substantial increase in gold investment in the euro area as investors seek to hedge, and gold investment has jumped from 70 tons in 2007 to more than 400 tons in four years. Recently, in the context of the threat of the new crown epidemic to the health and economic environment of Europe, coupled with large-scale monetary and fiscal stimulus, a similar demand response has been triggered (Figure 1).

Figure 1: During the COVID-19 pandemic, European gold investment significantly increased the demand for European gold bars and coins and the flow of ETP*



Data as of June 30, 2021. The shaded column indicates the first half of 2021.

Since the outbreak of the epidemic, the European Central Bank's loose monetary stance has boosted European gold investment. It is worth noting that despite the economic recovery and the increase in investor interest in risky assets, gold investment has remained flexible this year. World Gold Council market research shows that European investors who are worried about rising inflation and other issues recognize that strategic allocation of gold can help cushion further uncertainty.

At the same time, negative nominal interest rates may also play a role (see Figure 2). Since 2019, the nominal interest rates of major European sovereign debt have been low or negative for different maturities. Coupled with rising inflation, this means that the real rate of return is negative.

Figure 2: Gold and Eurozone negative-yielding debt are closely related to European negative-yielding bonds vs. gold prices*



* Monthly data from December 31, 2014 to July 30, 2021.

The demand for gold bars and gold coins is an important clue to gold retail investment. This demand has also been strong during the epidemic, because investors worried about inflation and low interest rates seek gold as a safe asset. So far this year, European gold bullion and coin investment has reached 146 trillion euros ($8.5 billion) in the first six months of 2021, the highest total investment in the first half of the year since 2009.

The European Central Bank’s monetary policy meeting is just around the corner, and economic recovery still faces three major risks


The size of the European gold market currently accounts for about one-third of the global annual gold investment demand, which means that the performance of the European economy and changes in monetary policy may therefore affect global trends.

At present, many investors are waiting for the ECB's upcoming monetary policy meeting and interest rate resolutions this week to capture guidance or signals about reducing asset purchases and raising interest rates. Although inflation has risen, the economic recovery is still at risk. It is expected that the ECB will have a fierce reduction debate at this meeting.

With the relaxation of blockade restrictions and the acceleration of economic activity in the entire region, economic indicators in the euro zone have recently shown signs of improvement. The latest forecast of the European Central Bank shows that real GDP will grow by 4.6% in 2021, 4.7% next year, and 2.1% in 2023.15. Market sentiment is also improving. On July 16, the European Commission’s economic sentiment indicator rose to its highest level in history.

But despite these advances, the European Central Bank remains cautious, reiterating that it is not prepared to change its monetary support policy until the economic recovery is firmly in place. However, if the central bank decides to keep the easing policy unchanged, this long-term stimulus may also increase additional risks.

Figure 3: Forecasts show that Europe’s growth forecast will lag behind the US real GDP forecast*



* Fourth quarter of 2019 = 100

In the underweight discussion, the most talked about European outlook risk is inflation. Prices have risen in recent months, with the Eurozone consumer price index reaching 3% in August, the highest level in 10 years. Although the European Central Bank predicts that the current rise in inflation will be temporary, institutional investors are increasingly worried about the level and direction of inflation if monetary policy continues to be loose.

The longer the expansionary monetary policy is implemented, the greater the possibility of unintended consequences. The loose monetary policy of the European Central Bank may distort asset prices ( Figure 4). Any sign of a slowdown in these asset purchases could lead to a correction in asset prices and undermine the economic recovery that the central bank has been trying to support.

Figure 4: European stock markets track the growth rate of the ECB's balance sheet since the launch of the PEPP Stoke Europe 600 vs. the ECB's balance sheet (all assets)*



*Data as of August 20, 2021. The shaded area represents the time period since PEPP was started.

On the other hand, because European governments are seeking to support their economies through the epidemic, governments have released unprecedented levels of expenditure. As a result, the government deficit has swollen, and the eurozone’s sovereign debt as a percentage of GDP now exceeds 100% (Figure 5). European corporate debt levels have also risen.

Figure 5: In response to the epidemic, the level of sovereign debt has risen significantly as a percentage of European government debt to GDP*



*Data as of June 30, 2021.

Although the vaccination rate across Europe has increased significantly after the slow start, there are significant differences in the number of fully vaccinated among EU countries, and the rising number of cases in several member states has overshadowed the recent rise in economic indicators. Cast a shadow. Although blockades and travel restrictions in the area have begun to relax, concerns about the delta variant and potential new variants have created significant uncertainty.

Although the region’s economy is recovering, European investors still need to ensure that they have adequate risk management. The investment characteristics of gold make it very suitable to help investors guard against many of these risks. It is not only a long-term hedge against inflation and currency devaluation, but also a high-quality, liquid asset that has performed well in times of crisis (see Figure 6).

Figure 6: After the systemic sell-off and subsequent recovery, the price of gold performed well. The performance of gold and Treasury bonds from the market trough (bottom) to the market recovery point (the stock market level before the systemic sell-off)*



Whether inflation will force the European Central Bank to tighten monetary policy remains uncertain. However, the World Gold Council believes that the European Central Bank’s cautious approach means that any interest rate hikes may be gradual, so as not to withdraw support prematurely. Therefore, even if a tightening signal is issued at the upcoming policy meeting, the European monetary policy environment seems to still support gold investment in the medium term. The European gold investment market is large enough to have a significant impact on the global gold market.

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