Super Mario (Draghi) struck again last week. At the ECB’s meeting in Frankfurt he announced a full-scale quantitative easing (QE) programme to boost economic growth and not least inflation. The bank plans to buy securities worth EUR 60bn a month starting in March this year and at least until September 2016. This is a substantial amount, and the programme is even launched after a period of historic monetary easing over the past several years.
The ECB’s motive for entering the fray with what must be considered its last tool is the slip in inflation expectations in tandem with the decline in actual inflation for quite some time. And in December actual inflation moved into negative territory for the first time since 2009. As the ECB has one mandate only – to keep inflation close to but below 2% – the need was felt to let the printing press run at full speed to bring inflation back to its target zone.
In practice, the ECB will buy bonds from financial institutions and thereby boost the sector’s liquidity and bond yields will simultaneously move lower. In addition, household, corporate and government borrowing costs will drop. This could support lending activity and thus lift economic growth and inflation.
But as the banking system is already awash with liquidity and interest rates are at ultra-low levels, it is difficult to imagine that the programme will lead to sharply higher lending. It is low for entirely different reasons at present. Firstly, lending activity is weak at a time when uncertainty about the economic outlook is prevailing. Secondly, with the new financial sector regulation, banks must set aside more capital when lending to notably small and medium-sized enterprises, which consequently feel that borrowing opportunities are scarce.
Hence, the effect of the programme will in all likelihood be the redeployment of financial sector assets. When government bond yields drop, equities or securities in foreign currency will become more attractive. The latter will lead to euro weakening, causing imported inflation to tick higher and competitiveness to strengthen. This creates inflation and boosts Euro-area growth and employment.
Dangers lurk under the surface
In that context, it is in many ways comforting that the programme does not run over a predetermined time horizon. Draghi & Co will not stop until inflation has returned to its target zone. Maximum support to the economic upswing via the financial markets should be secured.
It is worrying, though, that the programme may run for such a long time that financial market bubbles – perhaps also in a number of Euro-area housing markets – could inflate. Bubbles that could ultimately lead to new financial instability when and if they burst. That could also increase the risk of political tensions across the Euro-area countries. It is no secret that the launch of a QE programme has caused significant disagreement among politicians and central bank governors from Southern and Northern Europe.
Bear also in mind that the extremely low interest rate environment is making it increasingly difficult for the rapidly ageing population in Europe to live off their pension savings. And European pension companies will find it still more difficult to maintain their solvency.
So it is basically a dangerous course that Super Mario has embarked on to bring back inflation to 2%. This is also true even though he and the ECB have now assumed the role of Euro-area financial sector supervisors; this should ensure that new potential financial crises will be discovered and dealt with at an earlier stage than previously. Only time will tell whether my worries are completely unfounded.
Nordea