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Tuesday, April 08, 2014

Has the ECB actually moved closer to QE?

There has been a cacophony of comments from ECB members and ECB watchers over the past few days. However, the overriding view since ECB President Mario Draghi’s press conference last week is that the ECB has now moved a step closer to unconventional action such as Quantitative Easing (QE).

This is mostly down to two factors. First the following statement from Draghi’s presser:
“The Governing Council is unanimous in its commitment to using also unconventional instruments within its mandate in order to cope effectively with risks of a too prolonged period of low inflation…this statement says that all instruments that fall within the mandate, including QE [Quantitative Easing], are intended to be part of this statement. During the discussion we had today, there was indeed a discussion of QE. It was not neglected in the course of what was actually a very rich and ample discussion.”
Second, the FAZ report over the weekend that the ECB has been modelling the impact of a €1 trillion per year (€80bn per month) QE programme. While it suggested that such a programme would only raise inflation by between 0.2% and 0.8% (not a significant amount given the cost), the simple fact it is being modelled has been enough to give markets hope.

We believe QE or similar measures have become a bit more likely, but mostly because the market now seems to expect action and if the ECB is to maintain its credibility it will need to do more than simply talk.

That said, while there may be ‘unanimous commitment’ to using such measures when needed, it’s still not clear what the criteria are for such action and it is even less clear that all members of the GC agree on when such action would be needed. Draghi was pushed on this on the first question during the Q&A session, however, he never provided a direct answer.

Furthermore, much of the coverage has suggested that QE is in fact closer because the ideological opposition to such a measure at the Governing Council (GC) level has crumbled - although we're not sure that such a clear unified opposition ever really existed.

With this in mind then, it’s worth once again pushing the point that, in fact many of the issues with further easing are practical, political and/or legal rather than ideological at the ECB. We have previously analysed each measure in detail, below is a summary and links to all those posts:
Quantitative Easing (purchasing government debt)
We have detailed the issues extensively here (but also here and here). Draghi has hinted of these practical issues before, highlighting that they need time to design the programme and gather more information. Beyond political opposition in Germany and the legal limits to ECB financing governments, there is a clear problem in that the purchases would need to split according to the ECB capital key, meaning little would flow to the periphery where the deflationary forces are strongest. Add onto this the fact that QE in other countries has not been proven to boost the real economy or even bank lending as well as that it may exacerbate the squeeze on safe assets and it becomes clear that practically and technically this would be a very difficult step for the ECB to take and is not well suited to tackling the problem of low inflation.

Quantitative Easing (purchasing private assets)
See our detailed analysis here. The thrust would be to target purchases of assets which would help promote bank lending – the main one discussed is Asset Backed Securities (ABS), particularly ones made up of loans to the real economy. However, these markets in Europe are small and underdeveloped meaning the level of assets available and suitable for purchase would be minimal. The ECB has suggested it wants this market to grow but it’s tough to force such a move, especially in the short term.

Negative deposit rate
We analysed this option here. Since then the ECB seems to have made progress on the technical implementation of such a move. That said, the impact remains very uncertain. It could further reduce excess liquidity, force money market funds to shutter and force banks to pass costs onto consumers. On the plus side it could help weaken the euro.

A targeted LTRO (similar the Bank of England’s Funding for Lending Scheme)
Discussed, with other measures, here. A fairly simply option to take, however, given that there is already full allotment (unlimited liquidity at low rates) and banks have already repaid a lot of the previous LTROs there is no guarantee there would be any significant take up or that it would filter through to the full economy.

Ending sterilisation of the Securities Markets Programme (SMP)

A smaller measure, discussed in this post. While it would stop liquidity being drawn out of the system on a weekly basis, it’s not clear that this liquidity would flow to the real economy.

Further standard measures such as rate cuts and changing collateral rules
We rounded up such options a while ago here. Given that rates are already so low and that the transmission mechanism remains broken, the impact of such moves is likely to be limited to signalling intent rather than hoping for any significant return.
Overall, nearly all of these measures face quite serious practical, technical and/or legal obstacles.

Furthermore, it is unlikely that there is any consensus at the ECB GC level of when each measure is needed or what the triggers for such action are. The obstacles are also probably viewed to be different sizes by each national central bank. All that is to say, while it may have moved slightly closer, don't yet count on QE being much more than a last resort.


Alan said...

The problem is not just the choice of mechanism, but the confidence that you give to the market. You have to imply, regardless of the lever chosen, that you will pull it as long and deep as required.

The ECB gives no such confidence. If any mechanism is chosen, it will be applied sparingly, and to a tight limit.

A gentle tap on the brakes, followed by a period of analysis of just how fast we are approaching the wall. And then another brief tap, and so on.

Rik said...

Indeed hard to see why some are so positive on this.
QE sov debt will almost certainly trigger another BFG case which will delay it at best.
QE rest market simply not big enough and products simply are hardly available.
And 0.5% inflation (and 0.2-0.3% extra real growth if you are very very lucky is a horrible trade off for 1 Tn. Not even to mention creating a number of new bubbles, every market looks expensive already.
Rest seems to give little room under the present conditions. And when some would have room there will be a lot other problems to worry about than deflation.

Still missing a proper explanation how this all combines with internal revaluation.

Probably all has to be seen in a larger context of stresstests, overexposure in sov debt of mainly Southern banks. Combined with not having even remotely sufficient capacity to fill the actual capital gap.
Miracle that markets still accept these 'tests' a retarded buffalo can see that it is BS.
Problem the ECB is having is if for one of those they come under attack hard to see that the others will not start to play as well. And equally hard to see how they will properly defend the Frankford.

Bugsy said...

Who will fund Q.E., will it be the Euro Group or the whole 28 countries of the EU.

Are we being told that the non- Euro group are going to fund the potential recovery?

Rik said...

The printingpress (or better the digital equivalent thereof).

Jesper said...

About QE in the US:

"But magically creating jobs out of the same thin air where the printed money came from was never part of the Fed’s strategy – nor could it actually do that."

Rik said...

At the end of the day Draghi & Co would have to create financial products to buy time to try to solve the crisis that was largely caused by the same sort of products.

Complete lack of fundamental logic. Or: "How To Create And Maintain A Completely Unstable Financial System For Dummies".
Should be a bestseller.

The Euro is mainly doing well because investors are diversifying away from the USD. Plus there are not really other alternatives available. Not because it looks good by itself.

Just think how real jobs are created. Goods (not financial assets) that are consumed or invested in. If 6% of GDP QE creates less than 10% thereof inflation (which is basically in these 2), the rest moves somewhere else (asset bubbles).