22nd January 2015
The European Central Bank (ECB) has announced that it will start a quantitative easing (QE) programme in March.
The ECB said it will buy government bonds worth some €60bn per month – a figure higher than anticipated – until at least the end of September next year – read the full story here.
The move had been widely expected – we round up the expert reactions below:
Hermes group chief economist Neil Williams:
After three years of baby steps, Mr Draghi has today taken the giant leap forward financial markets were waiting for – but it will be no panacea.
By launching Eur 1.1trn in asset purchases over the 18 months starting this March and keeping the door open for more, the ECB will cement the impact of low borrowing costs, add liquidity, and, by trying to take the rug from under the euro, aim its first ‘bazooka shot’ at deflation.
This and his prior pledge to do “whatever it takes”, means Mr Draghi is doing a good job of addressing the symptoms of the crisis – escalating funding costs and, more recently, deflation. Also, his avoidance today of ‘blanket’ risk-sharing and skewing the bond purchases according to members’ capital contributions to the ECB will appeal to those worried that fiscal discipline would be thrown out of the window.
But anyone expecting the QE bazooka to quickly fix the problem – a monetary union still devoid of sufficient economic union – will be disappointed. Within the euro-zone, shifts in euro-members’ competitiveness are still far too disparate for that happen.
The biggest competiveness winner with the euro is still Germany, with the other, ‘satellite’ members having suffered a net deterioration. The good news is Spain and Italy are improving strongly. But, France’s competitiveness is eroding, and even Germany’s ‘bullet proof’ status economically is now threatened by a slowing China and upheavals in Russia
Tackling the causes of the euro-zone crisis needs years of work, and more than just QE – which, as we know from the US and UK, is a blunt instrument more likely to generate asset-price, than ‘feel-good’ demand, inflation.
Yet, without QE, some of the growth and tax benefits to Spain, Italy and others from their overdue competitiveness gains may not be maximised by a weaker euro.
The challenge is now to make sure the euro-zone does not follow Japan and let deflation take root. There, QE has been running for 16 years with little inflation impulse. The ECB’s ‘tap’ may be finally on, but, as Japan found out, QE acts like a drug: the more you use it; the more you need it. Euro-zone QE could thus be with us for many years to come
Anthony Doyle, head of fixed income at M&G Investments
The ECB clearly feels that its price stability objective is under threat due to falling prices and it is expected that the measures undertaken today will assist in generating inflation in the Eurozone.
Markets have reacted by focusing on the size of the QE package and the impact that a such large buyer of bonds will have on the market. We believe that in the short-term QE could force European government bond yields lower, meaning that investors will increasingly look for higher yielding investment opportunities. As a result, investment grade and high yield bonds could benefit from today’s announcement. In addition, the euro will likely come under increased pressure as European investors seek to invest globally in their hunt for a positive yield.
Over the longer-term, we believe that government bond yields will increase as today’s measures start to have a positive impact on inflation. We expect to see an improvement in the ability of European non-financial corporations and households to access credit which should boost demand. Additionally, any fall in the Euro could increase import prices and thereby inflation. It would also boost export production and therefore economic activity. With greater prospects for inflation and growth, European government bonds will likely come under pressure.
The ECB was late to the central bank liquidity party but it got there in the end. Arguably, the most powerful action is the commitment to continue QE until price stability returns to the Euro area. By embarking on QE, the ECB has signalled to the market that it will do “whatever it takes” to pursue its price stability mandate.
Ben Brettell, senior economist, Hargreaves Lansdown:
Initially markets had expected the programme to be around €500bn in size, but hopes for a larger injection of liquidity have been growing. As such today’s announcement of a €60bn per month programme lasting at least 18 months, or longer if deemed necessary to achieve the ECB’s inflation target, has largely matched expectations. Market reaction has therefore been relatively muted, with stock markets rallying slightly on the announcement and then falling back, and the euro left marginally weaker.
A Bank of England study suggests QE in the UK did little to increase bank lending. However, the size of the ECB’s programme, combined with its potentially open-ended nature, should convince markets that Mario Draghi is committed to fighting deflation.
A more immediate hurdle will be Greece’s elections on Sunday. Outright victory for the anti-austerity Syriza party could escalate ‘Grexit’ fears amid negotiations over new bailout terms when the current deal expires in February. Events will be watched particularly closely in Spain, where the new protest party Podemos is rapidly gaining support ahead of December’s elections.
Overall I believe the risks of not acting are greater than the risk of the measures announced today. In many ways the fact that Draghi has finally been forced to use his silver bullet is a measure of how bad the economic situation in Europe has become. Bundesbank officials have made it clear they don’t think economic conditions warrant QE, but few outside Germany would agree that today’s measures are anything less than necessary.
QE in both the UK and US has almost certainly boosted stock markets. When the central bank buys government bonds, the sellers receive cash. Unless they wish to increase the amount of cash they hold, they will use the money to buy other assets like shares, driving up prices. QE in Europe should therefore be good news for equity investors, at least for the duration of the programme.
A final question is what happens when the programme ends. Will we see a repeat of the ‘taper tantrum’ which occurred when the US Federal Reserve indicated it would reduce the size of its bond purchases? In many ways the ECB has simply kicked the can down the road as far as financial markets’ addiction to QE goes. At some point a helping of cold turkey will be necessary.
Colin McLean, managing director, SVM Asset Management:
The leaked proposal has already let markets do most of the work needed, lowering the Euro and government bond yields. Coming later in the cycle, it is less clear if the measures will make the same impact as those in the US,UK and Japan. The US and UK were dealing with a cyclical downturn, not deep-seated structural failure.
In the Eurozone, QE might further delay the need for structural reform in France, Greece and others – particularly in labour flexibility and the public sector. More of business financing, particularly SMEs, in Europe is via bank loans; the effectiveness of QE depends on whether banks’ behaviour changes.
Germany’s requirement that each nation bears its own credit risk does not really resolve some of the other issues in Europe, and may not sway voters in Greece. In summary, it is good for shares and financial assets. By cutting the Euro, and helped also by lower oil, it will give a boost for Eurozone industrials and exporters. It is likely the euro will lose further ground against other currencies, including pound and dollar.
Capital Economics chief European economist Jonathan Loynes :
The first details of the ECB’s quantitative easing programme suggest that it has met, and possibly even exceeded, expectations. The central bank will buy €60bn of assets per month from March until September next year, pointing to total purchases of about €1.1trn. This is close to the amount suggested by reports yesterday, but double the figure being mooted only a couple of weeks ago. At the equivalent of just over 10% of euro-zone GDP, it is close in size to the initial bouts of QE undertaken by the US Fed and the Bank of England and will meet the ECB’s stated aim to re-expand its balance sheet to 2012 levels.
There are some caveats. For a start, the €60bn monthly total includes the existing bond purchase programmes, which amount to something like €10bn per month. So the additional purchases are €50bn per month, in line with recent reports. Meanwhile, those purchases will consist of both investment grade sovereign debt and the debt of “agencies and European institutions”. And most of the government debt purchases will not be subject to “loss-sharing” – in other words, the risks will remain with national central banks, as had been mooted over recent days. This will surely limit the beneficial effects on the indebted peripheral countries. (Note, though, that Mr Draghi was careful to stress that risk-sharing would be fundamental to Outright Monetary Transactions.) Against this, though, one welcome feature is the pledge to maintain the purchases beyond next September if needed “until we see a sustained adjustment in the path of inflation”.
Overall, the fact that peripheral bond yields have fallen in response to the announcement suggests that, initially at least, the size and open-endedness of the programme is trumping concerns about the lack of risk-sharing. But we would caution again that even sizeable amounts of QE are unlikely to transform the outlook for the euro-zone economy and eliminate the risk of a prolonged and damaging bout of deflation.
Stephen Macklow-Smith, portfolio manager, JPMorgan European Investment Trust
Today’s ECB announcement undoubtedly means a lower Euro; it will continue to lose value against major competitors over the medium term.
This is a boost for European equity markets and in particular will support higher-yielding stocks. European financials will be incentivised to redeploy their assets out of cash, where they are likely receiving negative deposit rates, and instead invest in the wider economy. For banks that means more and healthier lending activity. For insurance companies that may include buying corporate debt and even equity at the margins.
For the European economic outlook, headwinds from the last several years are turning into tailwinds. Growth is recovering, particularly amongst those countries that have already restructured. Bank lending is gradually improving now that the stress tests are a memory of last year. Low inflation for the moment means that real incomes are growing, and this should help to underpin consumer confidence. Lower energy prices and commodity prices mean lower input prices for most companies, and this should help corporate confidence. We are optimistic for another positive year in Europe. Official policy is supportive, valuations are attractive, there is scope for earnings to grow, and corporate balance sheets are healthy.