The ECB Delivers QE; It Will Not Be Successful

25 Jan 2015 | Author: | No comments yet »

Draghi’s bazooka will not raise eurozone from dead.

Sometimes one hears the expression, “…better late than never…”. Frankfurt: Investors and financial markets have hailed the European Central Bank’s (ECB) latest monetary policy coup, but some observers warn that Europe might use up all its ammunition in the battle against deflation.

EUROPEAN Central Bank president Mario Draghi has called for deeper economic integration of the eurozone through joint policy in the areas of competition, bureaucracy reduction and labour markets after the ECB announced a large-scale bond-buying program. “There are good arguments for joint sovereignty in these areas — in the framework of a real economic union,” Mr Draghi wrote in an opinion piece to be published in German magazine WirtschaftsWoche. ECB chief Mario Draghi’s announcement on Thursday that the guardian of the euro would go on a €1.14-trillion ($1.27-trillion) bond-buying spree to drive up inflation in the euro area sent global stock markets soaring and pulled down borrowing costs. Each member should be able to attract capital and create jobs, he wrote, according to excerpts of his article published on Saturday by WirtschaftsWoche. “For that, we need structural reforms which foster competition, reduce bureaucracy and improve the flexibility of labour markets,” he wrote. Only one thing is certain about the apparently open-ended programme of quantitative easing promised on Thursday after months of ECB infighting; although quite a bit more ambitious than expected, in itself it won’t do the job, or anything close. On Thursday, January 22nd the President of the ECB, Mario Draghi, announced that the programme of buying assets worth EUR60 Billion (USD67 Billion) per month from March 2015 through to September 2016 was simply creating the framework within which growth potential can be realised.

Such reforms have been largely dependent on individual countries but the bloc has shared interests, he wrote. “By obliging governments to do structural reforms, the economic union makes it credible that countries can indeed overcome their indebtedness through growth,” and therefore gain investors’ trust, he wrote. If the programme fails, there will be no other measures to implement… and the prospects for the eurozone’s economies will be terrifying,” said Laurent Bakhtari, analyst at Swiss-based IG Bank. Capital markets should be united more rapidly so that the private sector takes a larger share of risks, he wrote. “Risk-sharing requires a deeper integration of capital markets, in particular stock markets.” The bond purchase programme, known as quantitative easing or QE, has already been used by the Bank of England and the US Federal Reserve to jump-start their economies. It is far too easy for the state to be expanded, and yet too many politicians, be they local, national or even supra-national cannot resist tinkering with the economic levers and have a reluctance to relinquish control.

Germany sees QE merely as sticking a plaster on weaker economies like Italy and Spain which, it argues, need instead to push through structural reforms to make them more competitive. The euro was mauled following the ECB’s decision, but this was little surprise considering the flood of new money due to hit the financial markets in coming months.

In short, the QE programme in the Eurozone will become an expensive failure if several national governments do not take this opportunity to implement meaningful structural reform. Germany is also concerned that, as Europe’s biggest economy and its effective paymaster, it would have to pick up the tab should another country default on its debt.

Draghi has already earned himself the nickname ‘Super Mario’ for the way he has galvanised policy-setting at the ECB since taking its helm in 2011 and transformed it from the German central bank model it was originally based on. Under his leadership —and in the face of unprecedented battles to save the euro — the ECB has repeatedly ventured into unchartered territory, by introducing negative interest rates, for example, or making vast amounts of cheap loans available to banks.

Since the financial crisis erupted six years ago, Western economies have leant heavily on their central banks to dig them out of the mess they are in. But with eurozone growth still sluggish at a meagre 0.2 per cent in the last quarter of 2014, Draghi has been compelled to roll out a central bank’s heaviest artillery, QE, and to design it in such a way as to make it palatable to the Germans. There is nothing wrong with monetary activism as such, but to believe it a panacea is to descend into fantasy, and it has now almost certainly reached the limits of its usefulness. In focusing solely on that goal it ignored the rise in unemployment to the current level of 11.5 percent and the folly of having placed monetary union ahead of transfer or political union became ever more apparent. That pushes down interest rates on bonds and other financial assets, making it cheaper for companies to borrow and invest, increasing spending and job creation.

The Fed was quick off the blocks to embrace quantitative easing, more than quadrupling its assets in the space of five years through its bond buy-back programme. Short of “helicopter drops” of free money, a policy which would amount to outright debasement of the coinage, there is little more that monetary policy can do. That having delayed QE for so long had serious consequences can be seen in the fact that the last time Eurozone consumer price inflation (CPI) was measured at 2.0 percent was December 2012.

Under Draghi’s scheme, the ECB will buy €60 billion of bonds, both public and private sector, per month starting from March and lasting at least until September 2016. It delivered a huge amount of cheap cash to consumers, businesses and investors, helping to spark economic recovery and hard-pressed financial markets to rally. With everyone now at it, race-to-the-bottom, competitive currency devaluation has become a zero sum game that, intuitively, we all know is likely to end badly. In any case, German aversion to use of the central bank printing press means the eurozone has been slow to join the party, and may already have missed the boat.

Month after month we sat through press conferences where the risk of deflation was denied until the December 2014 reading of CPI revealed a figure of -0.2 percent. Bizarrely, given the euro zone’s dire economic circumstances, the ECB turned the other way, allowing its balance sheet to shrink by about a third in the past three years, squeezing credit hard and leaving recovery to wither on the vine.

Draghi has made much of the price fall in energy and food and appeared reluctant at the end of last year to start QE lest such commodity prices accelerated higher once more. The plan to get the balance sheet back to 2012 levels around €3 trillion falls well short of €4 trillion needed to make any sort of dent in deflation. But the success of this programme, which critics in Germany have labelled the ‘nuclear weapon of monetary policy’ remains doubtful,” it wrote in a leader column.

ING DiBa economist Carsten Brzeski was similarly sceptical.”It seems that the ECB hopes for a happy end to a long fairy tale of fighting the euro crisis. Magnitude aside, there are lots of other reasons for believing that, coming so late in the day, eurozone QE will have less impact than in the US and Britain. Given severe headwinds posed by biting government austerity cuts, it would be no surprise if the ECB’s balance sheet ultimately rose above €5 trillion in the next five years.

With US quantitative easing reaching its conclusion and a similar move by the ECB in its infancy, the euro looks set to trade back down below parity against the dollar this year. Belief that the fast-devaluing euro will provide a life-saving boost to European exports and a surge in free-spending tourism is similarly just wishful thinking.

Crisis has been almost deliberately courted in the hope of driving structural and fiscal reform, but it has only succeeded in giving voice to radical populists, from Greece’s Syriza to Spain’s Podemos. As for Italy, Prime Minister Renzi who made such a fine start has over the past five months become bogged down under the weight of the shadow economy. Once the Greek election result is known and leads to a likely long process of accommodation it is unlikely that any other nation will embark on widespread structural reform. The wave of broad opinion is that Eurozone CPI is unlikely to be close to 2.0 percent before September next year, however, as with all things Eurozone one has to read between the lines.

That in itself will set the stage for many heated Governing Council sessions as they try to whether the adjustment in CPI that is being recorded is in line with the inflation target. President Draghi has expressed the thought that the QE will primarily impact inflationary expectations; where though is the evidence that central bank actions affect the expectations of households and companies. Draghi believes that the very act of will demonstrate the central bank’s determination to deliver targeted inflation even if there is limited evidence of a gain in employment, consumption and production.

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