All eyes on Fed, Greece after ECB fires bazooka

25 Jan 2015 | Author: | No comments yet »

All eyes on Fed, Greece after ECB fires bazooka.

PARIS (Reuters) – After the surprises from central banks which rocked markets at the start of the year, the U.S. The European Central Bank has now followed what a large part of the political and investment communities wanted – they have started a program of quantitative easing that exceeded expectations.ECB boss Mario Draghi avoided disappointment in his unprecedented QE programme with a plan that might just fix some of Europe’s problems, write Bloomberg’s Jeff Black and Scott Hamilton Mario Draghi has delivered a classic European compromise.“ARE the ECB’s bankers making our money kaputt?” Bild, Germany’s best-selling newspaper, has a way of saying what many Germans are thinking, while putting into plain German what others would render into tongue-twisting Teutonic syntax. Will this stimulus proceed like it did in the United States where most of the funds went into the “financial circuit” and very little going into the production of goods.

Europe’s new program of money printing — and the resulting fall in the euro — means the US economy must deal with a rapidly strengthening dollar that will make American goods more expensive abroad. The stronger dollar could slow both US growth and inflation, giving the Fed some incentive to hold off on its plan to raise short-term interest rates later this year from near zero. With a headline value of €1.14 trillion, the quantitative-easing plan unveiled by the ECB president last Thursday was welcomed by investors, even with its concessions to critics and a flurry of fine print. On Thursday, the ECB announced a package of security purchases that could total at least €1.1 trillion “in a bid to spur growth in the eurozone and countering deflation.” “The single currency had fallen through the $1.13 and $1.12 marks by midday, dropping more than 2 per cent against the dollar to $1.111 its lowest since 2004.” Mario Draghi, president of the ECB, wants to spur on domestic purchasing in the eurozone and also increase exports from the eurozone – both of which, he hopes, will keep Europe from declining into another recession and help to stop the deflation in the eurozone and renew price inflation. US officials have been playing down that scenario, and, more broadly, resisting talk of a global currency war — competitive devaluations by countries eager to keep their currencies as low as possible to protect exports.

The euro fell to an 11-year low and bonds rose after the long-awaited arrival of a mode of stimulus that central banks in the rest of the developed world adopted years ago. Draghi said the plan will help return inflation to the ECB’s goal, while still giving a nod to the German-led concerns that defined much of the region’s response to the financial crisis. “It’s a good start on a long road,” said Kenneth Rogoff, professor of public policy and economics at Harvard University. “They seem to have exceeded market expectations instead of underperformed, and that’s good. Expectations are for the U.S. central bank to stick to its guns despite the turmoil elsewhere, with top Fed officials citing in the past weeks strong U.S. economic momentum and falling unemployment. It’s clear that it had to be open-ended to raise inflation expectations.” The monthly purchases of €60bn through September 2016 will probably comprise about €45bn in investment-grade sovereign bonds, €5bn in the debt of euro-area public agencies, and €10bn under existing programmes to buy asset-backed securities and covered bonds, an official said.

But questions have been raised due to weak wage growth and five-year low oil prices that have dragged U.S. consumer prices down to their biggest drop in six years in December and heightened deflation fears in Europe. “What we will focus on in January’s statement, which could challenge our view about a June lift-off, are any hints of increased concern that very low headline inflation is putting downward pressure on inflation expectations,” analysts at BNP Paribas wrote in a note. “Any mention of foreign developments would also be dovish.” In any case, San Francisco Federal Reserve Bank President John Williams said a day after the Swiss central bank stunned markets, and even some policymakers, by lifting the cap on its currency against the euro that the Fed’s goal was “to not surprise or disrupt markets.” Central bank policy meetings in countries including Russia, South Africa, Israel, Sweden and Turkey will also try to tackle tumbling oil prices and the aftermath of the ECB’s quantitative easing plan, which sent the euro to an eleven-year low. Draghi during most of 2014, analysts and investors were not totally sure that he wanted to go into quantitative easing and that if he did move in that direction, the program would be on the tepid side. If it isn’t meeting its inflation objective, the programme will run longer, said ECB governing council member Visco at the World Economic Forum in Davos, Switzerland. “We are open-ended,” he said in a TV interview. “If we see that there are difficulties in achieving this target that we have, then we have to continue.” The ECB’s calculations show the programme will add 0.4pc to inflation in 2015 and 0.3pc in 2016, according to a second euro-area official.

But this is unlikely to win over critics such as the head of the federation of German exporters, Anton Börner, who said shortly before the announcement that “the so-called warm-water countries understand nothing but the hard words and deeds of the capital markets.” And after it was made, even Angela Merkel, the chancellor of Germany, expressed her worries that QE may slow down structural reform across Europe. Although around 90 percent of Greek debt is now held by official creditors, largely limiting the possible contagion from any fresh instability there, the country whose debt crisis once threatened the euro’s survival still carries risks. “We believe in the efficacy of QE,” JP Morgan analyst David Mackie said. “But, for now, we are not lifting our (euro area) GDP forecast in the face of potential new headwinds from political uncertainty in Greece and the much deeper recession in Russia.” After borrowing rates for euro zone countries fell to record lows on Friday, data throughout the week will give more news on the sluggish health of the currency area and the challenge facing the ECB’s QE plan. Among the factors driving the rise has been the US economy’s strong performance amid a slowing global economy, as well as signals by the Fed of a likely rise in interest rates this year.

Draghi has long maintained that euro-area governments must match the ECB’s spending power with economic reforms to boost productivity, labour flexibility, and investment. He underlined the same point when making his QE announcement. “The ECB has done it, has taken it further with a very expansionary measure,” he told reporters in Frankfurt. “But it’s now up to the governments.” The programme has built in the condition that Greece will only benefit from asset purchases if the new government that the Greeks vote for today continues along the agreed path of reform – despite promising the electorate to stir things up in Frankfurt. “Draghi is only too aware that whatever the ECB does on the monetary-policy side in an attempt to meet its mandate will not be successful unless governments do their bit,” said Janet Henry, chief European economist at HSBC in London. In a newspaper interview published beneath a picture of a melting euro, he notes the far bigger role played by capital markets in financing firms in America than Europe, where banks—which do not react to the same extent to money-loosening—are more important. The region’s leaders have so far started overhauling the banking system to spur lending and funnel credit to the businesses that need it – and with some success.

Some economic historians suggest that “hyperinflation phobia”—an irrational fear of rapidly rising prices—may be fuelling opposition to quantitative easing. They have more than halved since June but the Brent closed up on Friday at $48.79 a barrel, with the death of Saudi Arabia’s King Abdullah adding to uncertainty over the plans of the world’s biggest crude exporter. That means we may assume the ECB will keep buying, even beyond the September 2016 deadline. “We’ve seen over the last few years you have to trust in Mario,” said Larry Fink of BlackRock, in Davos, last Thursday. “As we have seen now, the market should not doubt Mario.” We don’t have to like the programme, but we should support it.” He went on to note that even the Bundesbank has agreed that the new scheme counts as monetary policy and is therefore under the purview of the ECB; it is not the “monetary financing” of shaky states, which is banned by treaty law.

The bank estimates prices for US imported consumer goods were down 1.7 per cent in January from a year earlier, a move its analysts said was associated closely with the stronger currency, which holds down the price of imports. Many US officials say privately they prefer a strong European trade partner — even at the expense of some exports — to a weak Europe with associated risks to global growth and financial stability.

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