April 2015 Issue
One of the worst kept secrets in Europe finally came to pass in late January as the European Central Bank (ECB) announced that it would be injecting at least $1.3 trillion into the faltering eurozone economy.
Under the plans, the ECB will buy $70bn worth of bonds from banks each month in a quantitative easing (QE) scheme that will last at least until the end of September 2016. The bond buying, which will include government and private sector bonds, is being carried out as the ECB attempts to raise its eurozone inflation target of just under 2 percent.
The program has also been designed to counteract the rise of deflation across the eurozone. According to the ECB’s statistics, in January prices in the eurozone were down 0.6 percent year on year. The drop is likely linked to the considerable fall in energy prices throughout the latter part of 2014. However, some commentators have questioned the scope of the ECB’s policy and its attempts to counteract the eurozone’s deflationary propensity – particularly as recent examples of QE in the US, UK and Japan have failed to demonstrate any conclusive proof that QE has any significant effect on consumer price inflation or deflation.
The ECB’s asset purchasing scheme will not allow the bank to hold more than 33 percent of any issuer’s debt and the bank will not buy more than 25 percent of any one issue. Furthermore, Greece will not be eligible for the new bond purchases until July 2015 under existing rules, and would have to continue with its austerity program to qualify. The implications of the county’s general election and fundamental rejection of Greece’s austerity obligations is still up for debate. However, the victory of the Syriza party will likely be impactful on the implementation of the policy, particularly in light of Greece’s negotiations with the European Commission.
“The program has also been designed to counteract the rise of deflation across the eurozone.”
QE has long been a controversial tactic, and the ECB’s announcement came just three months after the US Federal Reserve brought to an end its own $4.5 trillion bond buying program. Accordingly, the ECB’s decision to approve a QE scheme of this size at this time has been a controversial one. Indeed, German resistance to the policy has been one of the main reasons that the bank has held off on deploying QE in the past. Germany fears that by lowering the yield on sovereign bonds, the ECB’s QE policy will lower the cost of government borrowing for the eurozone’s many indebted members, such as France and Italy. In order to calm the fears of the policy’s detractors, the ECB has decreed that the eurozone’s 19 national central banks will carry out around 80 percent of the purchases and shoulder the risk of any purchases made.
But many commentators, both in and outside Germany, have been quick to dismiss the ECB’s plan. Bundesbank president Jens Weidmann and Sabine Lautenschlaeger, Germany’s member of the ECB’s Executive Board, were among the fiercest opponents of the policy, though they were by no means alone. The governors of the central banks of Austria, the Netherlands and Estonia are also believed to have a number of concerns about the policy, which has been likened to palliative care in some quarters.
Comparisons must also be made with the huge program of Japanese QE launched in the early 2000s as the country looked to claw its way out of significant economic stagnation. The Japanese program was considered too little too late at the time of its launch, and some commentators have levelled similar accusations at the ECB. Had the policy been launched in 2013 or 2014, some believe the scheme’s chances of success would have been far higher. Instead, the ECB could potentially preside over a euro collapsing under the weight of considerable deflation.
Yet despite the criticism, at this juncture the QU program appears to be one of the few remaining strategies available to the ECB. Whether it will be enough to revive the flagging eurozone remains to be seen. As has been well documented, the eurozone economy has been stagnating for some time. The recovery in the euro area in recent years has been weak, particularly in comparison with other regions. The endemic stagnation and declining consumer prices have forced the ECB into action. ECB projections show the announced measures should boost the euro area’s inflation rate by 0.4 percent this year and 0.3 percent in 2016.
The potential success of the policy will be up for debate for some time to come, as QE policies often do not produce immediate and obvious results. However, the plan will be either a positive step in the right direction for the wider eurozone, or the ECB’s final roll of the dice.
© Financier Worldwide
BY
Richard Summerfield