Tags: ecb | draghi | qe | economy

Draghi Dodges QE Dismay With Plan That Some Say Might Work

Friday, 23 January 2015 07:46 AM

Mario Draghi has delivered a classic European compromise. It even has a chance of working.

With a headline value of 1.14 trillion euros ($1.28 trillion), the bond-buying plan unveiled by the ECB president on Thursday was welcomed by investors, even with its concessions to critics and a flurry of fine print. Draghi pledged to spend until there’s a “sustained adjustment” in inflation and Italy’s Ignazio Visco said the program is open-ended.

The euro fell to an 11-year low and bonds rose after the long-awaited arrival of a mode of stimulus that central banks in the rest of the developed world adopted years ago. Draghi said the plan will help return inflation to the ECB’s goal, while still giving a nod to the German-led concerns that defined much of the region’s response to the financial crisis.

“It’s a good start on a long road,” said Kenneth Rogoff, professor of public policy and economics at Harvard University. “They seem to have exceeded market expectations instead of underperformed, and that’s good. It’s clear that it had to be open-ended to raise inflation expectations.”

Investors signaled the quantitative-easing program is sufficient, for now, with inflation expectations rallying. The Stoxx Europe 600 Index extended a seven-year high and bond yields declined from Germany to Spain. The euro was down 1.7 percent at $1.1172 at 1:27 p.m. Frankfurt time on Friday, near the weakest since September 2003.

Longer Run

The monthly purchases of 60 billion euros through September 2016 will probably comprise about 45 billion euros in investment-grade sovereign bonds, 5 billion euros in the debt of euro-area public agencies, and 10 billion euros under existing programs to buy asset-backed securities and covered bonds, a euro-area official said.

The program will run longer if it isn’t meeting its inflation objective, Governing Council member Visco said at the World Economic Forum in Davos, Switzerland.

“We are open-ended,” he said in a Bloomberg Television interview. “If we see that there difficulties in achieving this target that we have, then we have to continue.”

The ECB’s calculations show the program will add 0.4 percentage point to inflation in 2015 and 0.3 percentage point in 2016, according to a second euro-area official. Consumer prices fell an annual 0.2 percent in December, compared with the ECB’s medium-term inflation goal of just under 2 percent. Both officials asked not to be identified as the details are private.

Political Support

Those price projections signal the QE package needs to be complemented by other growth-boosting measures. Draghi has long maintained that euro-area governments must match the ECB’s spending power with economic reforms to boost productivity, labor flexibility, and investment. He underlined the same point when making his QE announcement.

“The ECB has done it, has taken it further with a very expansionary measure,” he told reporters in Frankfurt. “But it’s now up to the governments.”

He also kept up the pressure on the euro area’s perennial worry: Greece. The program builds in the condition that the country will only benefit from asset purchases if the new government that the nation votes for on Jan. 25 continues the agreed path of reform.

Fiscal Measures

“Draghi is only too aware that whatever the ECB does on the monetary-policy side in an attempt to meet its mandate will not be successful unless governments do their bit,” said Janet Henry, chief European economist at HSBC Holdings Plc in London. “Fiscal policy is still needed to boost aggregate demand to prevent a further drop in inflation.”

The ECB has arrived at this point -- the threat of a Japan- style deflationary slump -- even after spending the past five years focused on preventing the collapse of the single currency and trying to revive the economy. It has used interest-rate cuts, long-term bank loans, purchases of securitized debt, and a clean-up of the banking system.

Yet until now it held off from a bolder approach such as QE partly because of internal politics. More prosperous northern countries, most vocally Germany, have become weary of supporting spendthrift governments in the south.

The two German members of the Governing Council led opposition to the expanded asset-purchase program, according to euro-area central-bank officials. Bundesbank President Jens Weidmann and Executive Board member Sabine Lautenschlaeger were against implementing the plan now, said the people, who asked not to be identified because the deliberations were private.

Klaas Knot of the Netherlands, Ewald Nowotny of Austria and Estonia’s Ardo Hansson also expressed reservations, the people said. An ECB spokesman declined to comment.


“The purchase of government bonds is not an instrument like any other; it carries risks,” Weidmann said in an interview with Germany’s Bild newspaper published on Friday. “Political pressure to keep the interest burden on finance ministries permanently low” could increase, he said.

German Chancellor Angela Merkel reiterated her view that governments should rein in their budgets.

“The world is amply supplied with liquidity,” she said in Davos. “This liquidity supply is such that you can’t really precisely see who is competitive or who isn’t quite there yet.”

Draghi’s QE plan recognizes those concerns by imposing the condition that nations shoulder most of the risk themselves.

“One could argue that this type of approach Draghi is using should have been applied much earlier,” said Blackstone Group LP’s Stephen Schwarzman in Davos. “It is never too late to do the right thing.”

That said, some investors are pessimistic that Europe’s complex political system will ever be able to deliver the results needed to match Draghi’s historic effort.

‘Trust in Mario’

“For inflation to reach close to a 2 percent threshold over the medium term, the potential amount of asset purchases needed is 2 to 3 trillion euros, not a mere 1 trillion euros,” said Michel Martinez, an economist at Societe Generale SA in Paris. “The onus will remain on delivery of better-designed fiscal policy and structural reform. But it is difficult to be hopeful on these fronts.”

The region’s leaders have so far started overhauling the banking system to spur lending and funnel credit to the businesses that need it, and with some success. Credit standards eased for a third straight quarter in the three months through December and demand for loans is rising.

Still, reforms in big economies like Italy and France have been slow to arrive. That mean investors may assume the ECB will keep buying, even beyond the September 2016 deadline.

“We’ve seen over the last few years you have to trust in Mario,” Larry Fink, CEO of BlackRock Inc., said in Davos on Thursday. “As we have seen now, the market should not doubt Mario.”

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Mario Draghi has delivered a classic European compromise. It even has a chance of working.
ecb, draghi, qe, economy
Friday, 23 January 2015 07:46 AM
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