Eurozone: ECB launches full-blown QE to revive Euro area economy
January 22, 2015
The European Central Bank (ECB) launched its first full-blown quantitative easing (QE) program at its on 22 January meeting. ECB President Mario Draghi announced that the ECB will expand its current asset purchase program, which covers asset-backed securities (ABS) and covered bonds, to include government bonds. Beginning in March, the ECB will start purchasing euro-denominated investment grade securities that are issued by European governments and supranational agencies in the secondary market. The decision comes amid a scenario of persistent low inflation and stagnant growth, which have led the ECB to pursue additional action to revive the ailing Euro area economy, and comes in line with the ECB’s previous announcement that it would adopt further unconventional measures to address risks of an overly-prolonged period of low inflation, “should it become necessary”.
The ECB set a target for its monthly purchases at EUR 60 billion per month; considering that the current pace of ABS and covered bond purchases has been at around EUR 12 billion per month since the programs started, this sets additional purchases of sovereign bonds at around EUR 50 billion per month. While the ECB set a deadline for the purchase program for end-September 2016, the program is in fact open-ended as the Bank will continue purchasing assets until it sees, “a sustained adjustment in the path of inflation which is consistent with our aim of achieving inflation rates below, but close to, 2% over the medium term.” Given the pace of purchases, the ECB balance sheet will have swelled to around EUR 3 trillion by the intended deadline. This is equal to the size of the ECB balance sheet between June and November 2012.
Purchases will be distributed across countries according to their share of contribution to the ECB’s capital; however, the ECB will purchase only 33% of the bond outstanding of a single issuer // of any single issuer’s outstanding bond. Only 20% of the purchases will be subject to risk-sharing between the ECB and the National Central Banks (NCBs), while the NCBs will bear the risk of the remaining 80%. This arrangement was meant to accommodate some NCBs’ concerns —in particular, NCBs of core Europe countries, such as Germany, Netherlands and Finland—that ECB debt purchases would provide a disincentive for debt-ridden economies in the Euro periphery to rein in their debt burden. In that respect, the ECB will restrain from buying Greek government bonds for the time being, as they are rated non-investment; in fact, the details of the program imply that purchases of non-investment grade bonds of countries under an EU/IMF program cannot be made until the program is under review, as is the case of Greece.
Markets reacted positively to the bold ECB decision. The size of the program, in particular, exceeded expectations of market analysts who had pinned monthly purchases at just half of what Draghi actually announced. In addition, in the aftermath of the meeting, the euro dropped to an eleven-year low, closing the day at USD 1.14 per EUR.
Doubts remain regarding the impact of the QE program on the Eurozone economy, as skepticism persists as to whether this controversial measure will help to revive the Euro area economy. According to Pernille Bomholdt Nielsen, Senior Analyst at Danske Bank:
“The QE programme will support economic activity and it strengthens our view of a stronger recovery. The impact on activity works through a number of channels most of which are already contributing to higher growth.”
According to Danske Bank, the asset purchases will have a direct effect on the economy through more credit to the private sector; a weaker euro, which would make European exports more competitive; a wealth effect due to higher asset prices; lower yields on government bonds; and finally, portfolio rebalancing as investors move to new investment opportunities. In addition, the QE represents a signal that the ECB remains committed to support inflation.
However, according to Michael Schubert and Ralph Solveen, Senior Economists at Commerzbank, the overall impact of the QE measures will be more limited:
“[…] an ECB government bond purchase programme would probably only be able to boost the economy via a weaker euro, since other channels are blocked at present, and because, unlike the situation with QE programmes in the US, yields in the euro zone are currently already very low.”
Against this backdrop, it remains to be seen whether the ECB is open to adopting further measures in the future should the QE action pack not provide the expected support to inflation and growth. According to Carsten Brzeski, Chief Economist at ING-DiBa, the ECB has in fact dealt its final card and additional action can only be expected by national governments:
“There is no guarantee that QE will work. […]. This also requires further structural reforms, fiscal support and probably a longer, positive, vision for the entire Eurozone. Against this background, today’s QE announcement is historic but it was also the ECB’s last trump card. There are no more hidden aces. We have heard it often in the past but the flowery phrase that the ball is now back in the court of Eurozone governments has never been more true than today. Even worse, the ECB will not be able to pick it up again if governments try to play it back.”
Author: Armando Ciccarelli, Head of Data Solutions