Quantitative Unease

The Devil Is in the Details

The spotlight is on the European Central Bank, whose Frankfurt headquarters are shown above. Source: picture alliance / DPA
The spotlight is on the European Central Bank, whose Frankfurt headquarters are shown above.
  • Why it matters

    Why it matters

    Quantitative easing will likely define the ECB in 2015 – the most drastic step taken yet by the central bank to save the euro zone from the dangers of deflation.

  • Facts

    Facts

    • Most analysts expect the ECB to launch a U.S.-style quantitative easing program as early as January 22.
    • Inflation in the 19-nation euro zone could enter negative territory in December, down from 0.3 percent in November.
    • The ECB would be the last of the world’s major developed-world central banks to launch a quantitative easing program.
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    Audio

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Draghi-Reuters
Rushing towards the next ECB move. Source: Reuters

 

For those who still had their doubts, Handelsblatt’s interview last week with Mario Draghi seemed to end them: quantitative easing is coming to Europe.

The European Central Bank’s president fired up the expectations of financial analysts and investors that such a program, which would involve buying hundreds of billions of euros in government bonds, could be announced as early as January 22, the date of the Frankfurt-based central bank’s next meeting.

Mr. Draghi pointed to a dangerous spiral of falling prices and falling demand for goods in the euro zone currency bloc, which since the start of this year counts 19 countries among its members. “The risks of not fulfilling our mandate of price stability are in any case higher than they were six months ago,” he said, adding that the central bank has already begun “technical preparations” for its next move.

“Mr. Draghi’s comments lead us to believe that the ECB will announce a bond buying program at its next meeting,” Ulrich Leuchtmann, an analyst with German bank Commerzbank, told Handelsblatt.

Mr. Draghi’s comments pushed the euro currency to its lowest level since June 2010 on Friday, and have helped nudge it down even further since: Early on Monday, the freefalling euro hit its lowest level since 2006, breaking below the psychological barrier of $1.20 against the U.S. dollar.

“Everything is pointing to the euro falling further,” said Dorothea Huttanus, a currency market expert with Germany’s DZ Bank.

Mr. Draghi is likely to get even more ammunition this week: Experts believe that new data to be released on Wednesday is likely to show that annual consumer prices for the euro zone were negative in December.

The confirmation that negative inflation is already a reality could well tip the ECB over the edge, heaping pressure on the central bank to finally launch a program along the lines of what has already been done by the world’s major central banks in the aftermath of the 2008 financial crisis – the U.S. Federal Reserve, the Bank of England, and the Bank of Japan.

The ECB can’t just launch a program like those of other central banks – the euro zone is far too complex and unique.

The United States and the United Kingdom launched bond-buying programs back in 2009 – programs that are now coming to an end as their respective economies have recovered more quickly from the 2008 financial crisis than most of those in Europe.

But for the euro zone, the devil is in the details. The ECB can’t just launch a program like those of other developed country central banks – the euro zone is far too complex and unique for that.

Whether quantitative easing will work in Europe remains an open question for many economists.

The ECB has set itself a goal of buying as much as €1 trillion in assets on the open market. But unlike the United States, Britain or Japan, the ECB can’t just buy the bonds of one single country. It has to purchase bonds from as many as 19 different countries, navigating a series of economic and political pitfalls in the process.

Add to that the problems of the ECB’s mandate, its rule book. Germany’s Bundesbank, which has steadfastly opposed the ECB’s plans, argues that buying government bonds comes close to breaking the ECB’s rules against financing states – a rule that doesn’t apply to most other central banks.

 

The spotlight is on the European Central Bank, whose Frankfurt headquarters are shown above. Source: picture alliance / DPA
The spotlight is on the European Central Bank, whose Frankfurt headquarters are shown above. Source: picture alliance / DPA

 

Working groups within the ECB have been charged with hammering out the details of a plan – one that satisfies all sides as much as possible.

Sources within the central banking community say there are four specific criteria they are looking at to decide exactly how many bonds to buy from which countries.

The most important of these is the size of each country’s economy, which defines how much capital each country puts into the ECB. By this measure, Germany has the highest quota, effectively owning about one quarter of the central bank.

Back in November the ECB’s vice president, Vitor Constancio, suggested this capital key would decide how much of each country’s bonds the ECB would buy. But he and others have backtracked since, suggesting there is more going on behind the scenes.

Other criteria being looked at includes the depth of bond markets, which would see the ECB buy bonds based on how many are outstanding from each country. Italy would be the big beneficiary here, while Germany, which plans to issue no new debt this year, has fewer bonds on the open market.

ECB interest rates and balance sheet-01

 

Sources say that Germany and other countries from the euro zone’s core members are pushing for two other criteria to be included, which would effectively punish governments that have failed to meet their obligations to keep public spending under control.

One of these is “compliance” with the European Commission’s budget rules, which would rule out buying the debt of governments that the E.U. says are still failing to meet their obligations to curb public spending.

The other criteria are credit ratings, which would limit the ECB to buying the debt only of countries with a low likelihood of default. This would rule out Greece and Cyprus, for example.

A possible compromise being considered would involve the bonds being bought on the accounts of each national central bank, rather than on the account of the ECB itself. The Bundesbank’s president, Jens Weidmann, has said he would welcome such a step, even if the German central bank’s doubts about the program don’t end there.

Such a compromise could help solve a couple of problems. First, Germany’s concerns would be eased because it means their taxpayers wouldn’t have to pay for any potential losses stemming from the program.

Second, the flipside is that any profits from the program would stay within each country. That means that the higher yields the ECB would be getting from buying, say, Italian government bonds, would stay within Italy rather than ending up in Germany’s state’s coffers.

There are a number of compromise solutions being mulled within this. Some are looking at two programs: one with pooled risks and rewards and one without.

This could also mollify the Bundesbank. Keeping some of the risk within national central banks would also give each of them more control over their own programs. Each central bank would have a role in deciding how many bonds it buys. The Bundesbank, which is skeptical of the program, could then feel free to buy fewer German bonds.

Most market participants are still expecting the ECB to buy at least some German bonds: yields have been falling as a result. For the first time ever, yields on 5-year German Bunds turned negative on Friday. Yields on Spanish and Italian bonds also fell.

Draghi ECB-WTB

 

Norbert Häring holds a PhD. in economics and writes about monetary policy, exchange rates, credit markets and the latest academic developments in economics. Michael Brächer has been a Handelsblatt financial editor in Frankfurt since January 2013. Christopher Cermak, an editor with the Handelsblatt Global Edition in Berlin, contributed to this story. To contact the authors: haering@handelsblatt.com, braecher@handelsblatt.com and cermak@handelsblatt.com.

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