Fearing that slow lending, stagnant growth and, ultimately, deflation might take hold, last week the European Central Bank (ECB) announced that it was cutting its headline lending rate to 0.15 percent and taking its deposit rate to negative 0.10 percent. That means banks must pay the ECB to hold their money, a move the ECB hopes will spur lending.

While the US has operated with an effectively negative rate because the rate it pays doesn’t keep up with inflation, the ECB is the first major central bank responsible for a large, regional economy to explicitly set a negative rate. Up to this point, such action has been contained to smaller economies such as those of Denmark and Switzerland.

It will also make $545 billion worth of inexpensive loans available to banks with the caveat that they lend more to the private sector, particularly small- and medium-sized enterprises (SME). While details are still somewhat scarce, we know that first tranche euro zone banks will be permitted to borrow up to 7 percent of the value of their corporate loans with additional tranches of funding being made available in the coming months.

The bank has also said that it is entertaining the idea of its own American-style program of quantitative easing (QE), purchasing government bonds in the open market, though it is not yet ready to pull the trigger on that program.

The policy easing came after reports showed that annual inflation in the region fell to 0.5 percent in May and lending to SMEs, a critical component of the European economy, has continued to decline. SMEs actually make up more than 99 percent of all European business and provide two out of every three private sector jobs. Given the region’s reliance on small businesses, a significant slowdown in lending to the SME sector would have a serious impact on the region’s economy.

While it remains to be seen just how effective the ECB’s easing program will be, we’re already seeing its impact on emerging Europe. The Greek, Polish and Turkish markets have all posted strong gains in the wake of the announcement. The rest of that region’s emerging world should also continue the positive performance they’ve turned in so far this year, especially if the ECB ultimately decides to begin an active US-style QE program. While the goal of easing is to improve economic conditions at home, the money will ultimately flow to where it can find the greatest returns, as our own experience has shown.

At the same time we’re seeing a newfound zeal for reform around the world, providing a growth tailwind in countries as diverse as Mexico, India, China and Indonesia. Mexico’s round of legislation to liberalize its energy patch is expected by the end of July, India’s new prime minister is working to implement a general sales tax and to encourage greater foreign investment in his country. China has introduced a raft of private sector and banking reforms in recent months, with more expected before the year is out.

Overall, it appears that last year’s concern over tapering by the US Federal Reserve would spell the end of outsized returns in the emerging markets was overblown. Rather than bringing American easing to an abrupt halt, the Fed is essentially weaning the US economy from the life support it depended on after the Great Recession. At the same time, central banks in Japan and Europe are launching increasingly aggressive easing programs of their own, providing further support to the emerging world even as developing countries continue to get their own economic houses in order.

So while I don’t expect the emerging markets to manage another 78 percent return such as they did in 2009 in the remaining six months of this year, I wouldn’t be surprised to see them break 20 percent before we turn the page on 2014.

Portfolio Updates

It’s been a quiet week across the Global Investment Strategist portfolio with little news being released at the start of the summer holiday season.