QE, European Central Bank style, passed the markets test but will have a harder time doing as well for the eurozone economy or the currency union project.
Mario Draghi’s plan to buy €60bn a month of bonds met with success on narrow but important terms: driving eurozone stocks to a seven-year high and shaving two cents off the amount the euro purchases in dollar terms.
That’s excellent, because the plan, which will likely involve more than €1trn in bond buying by September 2016, has some notable flaws, both in its design and its essential nature.
The plan is designed to run until September of next year or until the medium-term inflation outlook hits 2%, whichever comes first. Crucially most of the purchases will be made by national central banks, rather than the ECB, with the eurozone central bank taking loss-absorbing risk on only 20%.
A euro of bonds bought is a euro to financial markets, and traders took the plan as being large enough to warrant the kind of moves the ECB would dearly like to see, and which represent the minimum hurdle for the plan.
A euro of bonds bought is not a euro in terms of the message the farming-out of risk to national central banks sends. The unmistakable message is that eurozone monetary policy is not a single thing, any more than eurozone fiscal policy. While the euro member states are certainly all in things together, they will all hang by ropes of varying lengths if things go wrong.
That is not tremendously helpful, though perhaps it is the price the policy had to pay to keep on the right side of German politics as well as the law.
Still, so long as the money is created and funneled into financial markets, we can depend on financial markets to make use of it. What is less clear is where the money goes or to what use it is put. While lower bond yields are a help to companies, they are also an incentive to take risks elsewhere, outside the eurozone, perhaps in places with unified policy.
Big for markets, small for eurozone
The other issue isn’t the size of the policy against expectations, but the size in terms of the impact it is likely to have on the eurozone economy. Here the news is far less good.
Reports in December indicated that internal ECB studies reckoned that a €1trn QE program would boost prices by just 0.2 to 0.8 percentage point after two years, somewhere between five and nine times less efficient than the equivalent studies for the US and UK. A similar study by Societe Generale concluded eurozone QE would be five times less efficient than in the US.
“The potential amount of QE needed is two to three trillion euros!” Societe Generale economist Michel Martinez wrote in a note to clients.
“Hence for inflation to reach close to a 2% threshold medium term, the potential amount of asset purchases needed is two to three trillion euros, not a mere one trillion. Should the ECB target such an expansion of its balance sheet, it would have to ease some conditions on its bond purchases (liquidity rule, quality …) or contemplate other asset classes: equity stocks, real estate investment trusts, exchange-traded funds …, as the BoJ, previously.”
Capital markets just do not play the same role in the eurozone economy, which is far more dependent on bank lending, as they do in the US. And the bond-buying plan does very little directly for banks, and nothing for bank capital levels, which are woefully low.
And the plan won’t help Greece, at least at first, as its bonds won’t be eligible for inclusion until the summer at the earliest, and only then if it remains in good standing with the ECB, the IMF and the European Commission.
Perhaps by then we’ll have a better reading on Greece’s ultimate direction, as negotiations over debt terms with whatever government emerges from Sunday general elections will be underway, if not likely concluded.
Until then we can probably expect financial markets to continue to enjoy the effects of eurozone QE. The silver lining too is that the plan is small enough and ineffective enough to stand as an incentive for the Federal Reserve to remain on hold.
Given that a Fed hike is probably just as frightening, if not more so, to risk assets as a Greek rupture, investors, if not Europeans, can be glad the ECB wasn’t able to be more bold.
(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication he did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)
