Tags: europe | easing | federal reserve | eurozone

European Central Bank Won't Be Easing Down the Same Road as the Fed

Friday, 23 January 2015 02:20 PM Current | Bio | Archive

The European Central Bank (ECB) has announced its bigger-than-expected quantitative easing (QE) program whereby the ECB and the 19 Eurosystem Central Banks (eurozone) will start buying euro-denominated investment-grade securities issued by euro area governments and agencies at the rate of 60 billion euros ($68 billion) a month until September 2016, which should amount to 1.14 trillion euros ($1.27 trillion).

However, it might not be limited to that amount and would be continued until a sustained adjustment in the path of inflation (consistent with the ECB’s aim of achieving inflation rates below, but close to, 2 percent) becomes firmly established.

Please note that five ECB Governing Council members dissented with starting the QE program now because they didn’t agree on the timing, but also because the ECB had decided that 80 percent of the risk of the purchases are with national central banks while the remaining 20 percent would be mutualized in the form of agency purchases as well as of the ECB’s own portfolio of bonds.

The dissenters were the representatives of Germany (Bundesbank President Weidmann and Sabine Lautenschlaeger), the Netherlands (Klaas Knot, President of the Dutch central bank), Austria (Ewald Nowotny, President of the National Bank of Austria) and Estonia (Arno Hansson, President of the Estonian central bank - Eesti Pank).

As an investor, I would remain extremely cautious about the (for now, at least) expected effectiveness of the QE in generating inflation.

The ECB’s QE effort will be judged by the facts and if it will finally be able to cause inflation to rise to close to 2 percent within the eurozone before the end of September.

When we take a realistic view on how the QE programs in the U.S., the UK and Japan have impacted inflation in their respective countries, then we must admit the probabilities for success of the ECB’s QE before the end of next year are rather slim as none of the three aforementioned countries have been able to achieve and certainly not sustain their respective inflation targets notwithstanding their extraordinary QE programs.

Of course, it’s practically impossible to make solid comparisons among these four economic power houses. Maybe it could help investors somewhat when the questions about the effectiveness of all these QE programs are raised.

Only in the U.S. we have seen money and credit growth caused by QE, but we should not overlook that fact that QE in the U.S. has had little to do with “demand” for loans by companies.

What really is mind-boggling is that the ECB launches its important, but surely (in my opinion) not sufficient QE program at a moment when the eurozone still has to come to terms or better said has to apply finally a whole range of real and absolutely necessary structural reforms such as labor reforms, product reforms, which imply among other important elements competitiveness, etc.

The only thing that’s for sure, at least in my opinion, is that we probably will see a prolonged debasement process of the euro, which will in the end hurt all those who will have invested in euro denominated assets, which doesn't mean that at a later stage there will be real buying opportunities.

We haven’t seen the bottom of the euro yet.

I now expect, in great part because of the “open-ended” aspect of the ECB’s quantitative easing program, the euro to continue its slide to even below parity with the dollar while it wouldn’t surprise me at all if, and of course that’s a big if, the QE program doesn’t deliver on today’s way too high expectations before the end of 2016, exchange rates of 80 to 90 dollar cents per euro are in the cards for 2017 or even before.

I also think the QE will incite, but only in part, an increase in euro outflows out of the eurozone, which implies the euro is definitively on its way to become a major “funding” currency for carry trades for quite some time to come.

Finally, if such a scenario would further evolve and would take hold and not withstanding that Italian Prime Minister Matteo Renzi said on Wednesday that he welcomed the recent decline in the euro and he wished the eurozone’s single currency traded at the same level as the U.S. dollar, saying: “My dream is parity.”

I wouldn’t be surprised the eurozone is, because of the debasement process of the euro, on its way for serious internal political disputes among the QE supporters on one side and the QE dissenters like Germany, the Netherlands and Austria on the other side.

In this context I’d like to add Renzi probably should better take care what he wishes for.

The zone for the euro below parity with the dollar is definitively on the horizon. Long-term investors could do well taking that into account when making investment decisions.

That said, I don’t expect QE in the eurozone to have the same impact as the U.S. QE programs caused worldwide, as euro’s share in the global financial system (reserves) is these days at 22.6 percent compared to 62.3 percent the dollar represents of the global reserves.

That doesn’t mean what goes on in the eurozone isn't extremely important to all economies in the world, the U.S. included.

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I don’t expect QE in the Eurozone to have the same impact as the U.S. QE programs caused worldwide, as euro’s share in the global financial system (reserves) is these days at 22.6 percent compared to 62.3 percent the dollar represents of the global reserves
europe, easing, federal reserve, eurozone
Friday, 23 January 2015 02:20 PM
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