The ECB’s QE program allows for much-needed flexibility

Against the background of an already recovering economy, the ECB’s large-scale government bond purchases are neither necessary nor are they likely to have much impact. One positive aspect, however, is that the design of the bond purchase program allows for a certain degree of flexibility. The ECB can, and should, reduce or stop monthly purchases if the economic situation improves and inflation trends point upwards again. The decision to make national central banks responsible for a larger share of the bond purchases is welcome. Sufficient coordination and control should be ensured.

 

In our view, the large-scale government bond purchases announced by the ECB would not have been necessary, as the economic situation in the euro area is in any case improving and the outlook for 2015 is positive. The depreciating euro and the collapse in oil prices are reinforcing the economic recovery. Weakening the euro much further would entail the risk of severe overshooting in currency markets.  But since the ECB's decisions are largely in line with market expectations, we do not expect any drastic depreciation. Oil and commodity prices are currently the main determinants of consumer price developments. The drop of inflation, in some places to below zero, is not a sign of dangerous deflation. The impact of the announced measures on the economy, inflation rates and inflation expectations, which depend to a considerable degree on current price developments, will be extremely limited. Bank liquidity is already very high, and liquidity shortages are certainly not the reason for sluggish lending activity. Rather, the recent improvement in bank lending standards reflects improved capital ratios and risk-bearing capacity, which are themselves partly the result of regulatory tightening. The rates at which euro area governments can refinance themselves are already very attractive and contain only minimal risk premiums. A further slight drop in yields will not have any significant impact on business development.

Notwithstanding our skepticism regarding the necessity of the ECB’s new measures, we see some positive aspects in the design of the bond purchasing program. The planned monthly purchase volumes (for all QE measures, not only for government bonds) offer a certain degree of flexibility. This hopefully implies that the ECB is not committed to a rigid balance sheet objective (of around EUR 3 trillion) and that the strategy will be reviewed whenever conditions change. The announced duration of the monthly purchases roughly matches that of the commitment to provide unlimited liquidity in tender operations until the end of 2016, and with the time frame for conducting targeted longer-term refinancing operations. The duration can be extended if conditions require. Conversely, it must be possible to cut back on the monthly QE volumes earlier, or suspend the purchases entirely, if inflation starts to recover and moves towards the ECB’s reference value of below but close to 2%. This could happen if oil and commodity prices bottom out and start to recover.

The fact that the national central banks of the Eurosystem will be purchasing a larger portion of the bonds on their own account/at their own risk has the advantage of limiting the mutualization of risks (which has no legitimate basis in a monetary union without a fiscal union). This certainly does not imply a renationalization of monetary policy, as the ECB will be responsible for coordinating and monitoring the national central bank purchases.What is more, the weighting of government bond purchases based on the ECB's capital key will limit any transfer of risk.

All in all, the ECB has succumbed to self-inflicted pressure. The hope now must be that we have reached the end of the line; that markets will not demand even further action any time soon, and that the ECB will not start raising new expectations.

As with all content published on this site, these statements are subject to our Forward Looking Statement disclaimer:

 

Dr. Michael Heise
Allianz SE
Phone +49.89.3800-16143
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