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The ECB could someday add buying stocks to its list of policy moves, Wall Street strategists say

Key Points
  • The European Central Bank could ultimately add stocks to the assets it purchases in an effort to shake its economy out of the doldrums by prompting companies to do more investment and spending.
  • The ECB left rates unchanged Thursday, though analysts expect it to take action in September with a rate cut and possible enhancements to its quantitative easing program.
  • The net result of equity purchases should be to make equity financing more attractive for companies, according to BlackRock's Rick Rieder.
IMF's Managing Director Christine Lagarde with ECB's president Mario Draghi.
Eric Piermont | AFP | Getty Images

The European Central Bank could at some point add equities to the list of assets it would buy to shake Europe out of its doldrums and stir up some inflation, according to market pros.

The ECB left interest rates unchanged Thursday but said it would act if needed to ensure its inflation objective and would keep rates steady or lower through the first half of next year. Strategists widely expect the ECB will cut rates at its September meeting and discuss expanding the type of assets it is buying. And at some point, strategists say, it will discuss putting stocks on its buying list.

The July meeting was one of the final three to be run by ECB President Mario Draghi before Christine Lagarde, chairwoman of the International Monetary Fund, takes the helm of the central bank in November.

Rick Rieder, BlackRock chief investment officer of global fixed income, said the European negative interest rate policy has actually had the effect of making equity financing more expensive for European corporations.

For instance in project finance, if the return on the debt is too low, it would be much more attractive to investors to help fund the project through equity. The difference in the cost of equity versus debt financing has changed the capital structure in Europe. Public companies using low yielding debt have taken on  too much debt, and the cost of using equity to finance has become too expensive.

"If rates are at zero, instead of what is a normal debt financing, everyone moves to the equity, and you've actually increased your cost of capital," said Rieder. He said the negative yields in Europe have created a negative velocity that hurts the banking system, pension funds and insurers.

Rieder said multiples on European equities are low, and the central bank could make targeted purchases in the market through ETFs or select sectors. "European equities are not expensive at all," he said in response to a question on whether the ECB would create a stock market bubble with stock purchases.

"The most bizarre thing is people are buying European bonds for upside appreciation and European stocks for carry," said Rieder, who is also lead portfolio manager for BlackRock's Global Allocation Fund, the firm's largest mutual fund

"Until you get to equity investment and bring down the cost for companies to invest, you're creating anomalies that don't create growth and aggregate demand," he said.

He said there's been underinvestment in Europe, and righting the capital structure, so it's not so tipped toward debt would be healthy.

"You're reducing their cost of financing and creating a more normalized capital structure. Companies can't load more debt on their balance sheet. If you restructure their cost of equity, all of a sudden they can use equity and debt in capital expansion and make an acquisition, capital expenditures and build inventory," Rieder said.

Ethan Harris, Bank of America Merrill Lynch's head of global economic research, said he also expects the ECB to move to equity purchases at some point in the future.

"It would give a little more power to the unconventional policy easing. You have to do where you're buying indexes where you're buying a broad range of things. ... You want to avoid buying winners and losers," said Harris.

He said it should encourage companies to invest. "Your'e both encouraging companies to borrow and invest through the markets and you're encouraging household spending based on the wealth affect," he said.