25 years of the European Central Bank: analysing its impact

On 1 June 1998, the European Central Bank (ECB) was established and, shortly after, on 1 January 1999, the euro was launched, in what was to be the world’s largest ever currency changeover.

Over the past 25 years, that monetary union has been tested on many occasions, including the great financial crisis, sovereign debt crisis, the pandemic and, more recently, the banking crisis. While many have questioned whether the union could survive some of these events, survive it has and, according to ECB president Christine Lagarde, “on each occasion, it has emerged stronger.”

Speaking in Frankfurt on 24 May, she said that the ECB now needs to build on that inner strength. “Faced with shifting geopolitics, digital transformations and the threat of a changing climate, there will be more challenges ahead which the ECB will need to address. We must continue to provide stability in a world that is anything but stable,” she stated.

“It is now time for the next chapter in the euro’s story to be written,” she continued. “For the ECB, our immediate and overriding priority is to bring inflation back down to our 2% medium-term target in a timely manner. And we will do so.”

How has the European stock market performed?

Over the quarter of a century, the European stock market has performed well, returning 293.4%*. It has outperformed both the UK and Japanese markets but has lagged the US.

European equity funds have done considerably better, with the average fund in the IA Europe ex UK sector returning 331.5% and the average IA European Smaller Companies fund returning 677% over the same period*.

Not all European equity funds that are around today have a 25 year track record, but of those that do, Elite rated funds have excelled. Elite Radar Jupiter European has returned a phenomenal 940.9%*, for example. Barings Europe Select Trust is not far behind on 855.9%, while Janus Henderson European Selected Opportunities and CT European Select returned 596.7% and 550.5% respectively*.

What do the managers have to say?

Chris Garsten, lead manager of the Waverton European Capital Growth fund, has slightly less rose-tinted glasses than Christine Lagarde about the beginnings of the monetary union. “What should have been a multi-decade period of harmonisation and growth fairly quickly descended into chaos,” he said. “It took the famous July 2012 statement by then ECB president Mario Draghi that the ECB would do ‘whatever it takes’ to save the euro and stabilise the situation.

“The direct impact of the turbulence has been very low confidence, especially amongst British and to a lesser extent US investors, to put money into the euro area,” he continued.  “The secondary impact of the banking crisis and the ever-tightening ECB regulation is that Financials have generally been very poor investments. They have more than halved in importance – from being over a third of the market to around 16% today. Fortunately, Europe has a broad offering of companies to invest in, unaffected by the above negatives.”

David Walton, manager of IFSL Marlborough European Special Situations, is more positive saying that the ECB has provided effective monetary policy and bank supervision through a series of challenging periods. “There is also evidence that the euro has significantly increased the amount of trade between Eurozone members, which underlines the importance of the common currency and the ECB’s support for it,” he said.

What the ECB hasn’t been able to do, according to David, is to cure some of Europe’s continuing problems, such as sluggish productivity growth, relatively high labour costs and excessive bureaucracy. “However, European companies have shown ingenuity and resourcefulness in navigating these challenges and this has been reflected in strong performance for investors,” he stated.

James Bird, analyst at the European Opportunities Trust, is another who has not been impressed by the central bank. He says that “capital flows from post-reunification Germany and ineffective response mechanisms proved to be the defining features of the ECB’s pre-pandemic existence” and that “although initially effective in stabilising markets, the combination of low rates and QE simply led to asset price inflation, rather than money supply growth in the real economy.”

“The pandemic represented a dramatic shift: governments took charge of the money creation process by underwriting bank loans, whilst the ECB assisted an explosion of government debt through a step up in bond purchases. In doing so it was complicit in, but not the main driver of, the post-pandemic inflation,” Bird added. “The culmination of this 25-year period is an historic level of household and government debt, together with newly empowered state governments in the field of money creation. The result is likely to be a reversal of the pre-pandemic era: transfers of wealth from savers to debtors through financial repression.”

“Europe today is a very different place to that of 25 years ago,” added the T. Rowe Price European Smaller Companies Equity team. “It is far more integrated, with membership of the European Union expanding and far closer coordination in areas such as foreign policy, industry regulation and, more recently, “green” initiatives.

“Key has been the development of the ECB, with a specific mandate to ensure price stability across the euro zone. The corporate landscape has been transformed, with European companies benefiting from technological, industrial, and scientific advances. At the same time, rates of economic growth have lagged those achieved in most other regions of the world.”

The team is more positive about the success of the central bank. “The ECB has evolved into being one of the most credible central banks, providing a strong institutional and regulatory framework for Europe. It has ensured price stability in the euro area,” the team said. “Mistakes have undoubtedly been made, such as the initially weak response to the GFC, and interest rates have been unnecessarily restrictive at times. But the bank was often constrained by political and national factors. There have also been clear successes, such as the eventual resolution of the debt crisis, and the establishment of a strong regulatory framework for financial institutions.”

So what of the future?

“Historians will long tussle over the relative success of the European project and the ECB,” said Benjamin Moore, manager of CT European Select. “Successful equity investing takes account of some [macro] factors, but for our fund it revolves more around the selection of successful business models,” he said. “Our focus is on finding high-quality business models whose success transcends and outlasts these shorter-term policy moves, and it is on this that our long-term investment success is based.”

“European economies have generally displayed a good degree of resilience in the year to date against a backdrop of continuing geopolitical and economic uncertainty,” the T. Rowe Price team continued. “Inflation remains a key concern, and there is the risk that it remains stickier than many investors expect. Interest rates have already moved sharply higher, and further hikes may strain household and corporate resources. The actions of the ECB will be critical, and it must avoid a policy error of over-tightening rates if its reputation is to continue to improve.”

“In the race to decarbonise, stakeholders want to see net-zero strategies in place,” said Chris Garsten. “To achieve this technical skill sets will be vital and are often in short supply. This should suit Europe to a tee with its deep skill set. It will be an investment-led cycle benefitting sectors that make ‘stuff’ – tangible outputs such as energy, materials, capital equipment, and industrial technologies.”

David Walton concluded, “Looking ahead, although many of our companies continue to report resilient trading, slowing economic growth, rising inflation, and the impact of the war in Ukraine mean there are clear challenges for European businesses. Inevitably this has had an impact on company valuations. However, it has also created an opportunity to buy quality companies at significantly lower share prices and we believe this presents a highly attractive long-term opportunity.”

*Source: FE fundinfo, total returns in sterling, 1 June 1998 to 24 May 2023

_{Photo by Christian Lue on Unsplash}