With interest rates already at zero, the ECB, as had been widely expected, decided at last week’s council meeting to expand its asset purchase programme to include public debt, in effect launching a full-blown quantitative easing (QE) programme, writes Oliver Mangan.
This latest policy easing move allows for the purchase of government bonds in the secondary market.
The expanded programme is larger than markets expected, at €60bn per month, up from around €10bn at present. The purchase of sovereign and other public bonds will commence in March and the expanded programme is intended to last until at least September 2016.
It will be conducted until there is a sustained change in the path of inflation consistent withachieving a CPI rate of close to 2% over the medium term. The eurozone inflation rate currently stands at –0.2% and it is expected to move even lower in the months ahead.
However, most of the risk from the purchase of the public bonds is not being mutualised, unlike with the securities that the ECB has been buying under its current asset purchase programmes.
Up until now, the national central banks shared responsibility for the losses and profits from the ECB’s asset purchases.
Under this expanded QE programme, the national central banks will assume the credit risk for 80% of the additional asset purchases of some €50bn, effectively passing it on to national governments. In total, it means that around two-thirds of the overall QE programme will not be subject to risk-sharing among central banks.
There have been some concerns that this may limit the effectiveness of the QE programme. It could also raise questions about how committed some member states are to deepening banking and monetary union in the eurozone.
It might also lead to a deterioration in the perceived credit worthiness of highly indebted countries, with possible negative implications for their credit ratings.
The intention of the ECB is to expand its balance sheet by over €1.1 trillion through the QE programme. Although €1tn may sound a lot, this is still quite small-scale QE compared to what was done in the US and UK.
The US Federal Reserve’s QE programme totalled $4.5tn, or over 25% of GDP, much greater than the ECB’s, which will amount to less than 12% of GDP. However, this could grow if the QE programme is increased or extended.
The QE programme is not a panacea for the ills of the eurozone economy. The president of the ECB, Mario Draghi, warned that all monetary policy can do is create the basis for growth. Governments also need to act and implement structural reforms that will boost economic growth.
He argued that the more they do this, the more effective monetary policy will be. He also called for “growth-friendly” fiscal consolidation to help boost confidence and activity.
The eurozone economy should benefit from the sharp fall of the euro over the past six months, which in large part is due to the loosening of policy by the ECB.
The euro dropped like a stone after the QE announcement last week, as the expansion of the bond buying programme was greater than the market had expected.
The euro fell to 75p against sterling, its lowest level since 2008. It is down to an 11-year low of $1.12 versus the dollar. This compares to a rate of $1.25 in mid-December and a high of $1.40 early last summer. The EUR/USD rate looks set to hit $1.10 much more quickly than we had anticipated.
The euro may find support around this level, but the question is for how long?
If expectations of a US rate hike in 2015 remain intact, then the dollar is likely to go even higher. Thus, a move towards parity for EUR/USD could well be on the cards for later this year.
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