ECB QE: Postponed, but not scrapped

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By Holger Fahrinkrug, chief economist at Meriten Investment Management

After the last ECB Council’s meeting in 2014 Mario Draghi reiterated that the ECB would decide “early next year” as to whether it would expand its asset purchases (QE) to include government bonds, depending on the data then available.

Falling oil prices, inflation rates and inflation expectations as well as lowered ECB growth and inflation forecasts for the years ahead were not enough to trigger a decision right away, much to the disappointment of some market participants.

Barring any significant changes in the underlying data, it is to be expected that from now on each ECB Council meeting will be preceded by a bout of speculation about a potential introduction of a broad-based QE programme, but it may well take until the Council meeting held in March or April before a resolution will be adopted (i.e. either 5 March or 15 April 2015).

There is still uncertainty about whether the ECB will indeed buy government bonds, in spite of all the reservations about the legal or economic implications the German central bank might have. But the statements made by Mario Draghi in the last few weeks suggest that the probability has now risen to over 50%.

What are the arguments in favour of this move? Is Draghi’s fear of a deflationary spiral warranted? Will data improve in the first quarter of 2015? And what would be the consequences of an extensive QE programme in the euro zone?

Impact of QE

We expect QE to have only a relatively small effect on the eurozone’s economy, as monetary policy has been accommodative for a very long time, the yields of the assets to be purchased by the ECB are at ultra-low levels and expectations of fixed income markets regarding QE have already gotten well ahead.

It is thus rather unlikely that much additional impetus will come to the real economy through the interest rate channel. The same applies to the public finance channel as financing costs of EMU member states have been very low for quite some time now and there are other factors to blame for budgetary discipline.

However, Mario Draghi and most market observers are expecting the euro to weaken further and substantially. This would mainly benefit countries with strong external trade relations outside the eurozone, e.g. Germany.

It is expected that without meaningful export sector or countries that are heavily reliant on imports may initially be adversely affected, although this may be somewhat cushioned by lower commodity prices.

Last, but not least, a continued depreciation of the euro would make assets cheaper for international investors, thus attracting more investments and fostering job growth.

This all hinges on whether investors have confidence in the ECB’s success. However, their trust could be undermined by a continued lack of reforms in the eurozone’s problem countries.

All in all, it is expected that the eurozone’s medium to long-term growth outlook will hardly be driven by monetary policy areas. As Mario Draghi has put it, other policy sectors will have to pull their weight too, meaning that in order to stimulate growth, product and labour markets would also need to undergo reforms.


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