Markets Insight

April 24, 2014 6:23 am

ECB QE: real prospect or fantasy game?

And will it work to weaken euro and stave off deflation?

When Ben Bernanke launched US quantitative easing in late 2008, the Federal Reserve chairman threw a match into a box of fireworks: the subsequent rally in global share prices was dazzling.

Continental Europe would never be as ostentatious. More than five years later, the European Central Bank is edging towards QE – large scale asset purchases – to fight off eurozone deflation threats. The market impact might not be as crowd-pleasing.

Bonds and equity markets have already anticipated any announcements – the risk is of a correction if Mario Draghi, ECB president, disappoints. If the impact of QE on economies depends on boosting investor confidence, the eurozone version could be less effective than hoped.

The ECB might not even light the match. One school of thought among market strategists is that Mr Draghi is bluffing – although everyone admires his chutzpah. The ECB president is a master at poker. In July 2012 he prevented a eurozone break-up by pledging “whatever it takes” to preserve its integrity. In the end he did not spend a cent.

Fantasy buying

Now ECB policy makers are speaking increasingly openly about possible QE. In Washington earlier this month, Benoît Cœuré, executive board member, discussed at length what assets the central bank might buy. Not a few bankers and investors suspect an elaborate hoax: that the ECB is trying to talk the euro lower by playing fantasy QE. At the very least, it may be many months before the real thing is attempted.

If verbal interventions failed to weaken the currency and deflation risks mount, the actual implementation of QE may not have the same, easily recognisable effects as in the US or Japan.

A big problem is that the ECB would be late to the show. It needs desperately to weaken the strong euro, which is hitting exporters as well as pushing inflation lower. But QE has pitted central banks against each other in a competition to devalue currencies – and the Fed and the Bank of Japan have had the advantage of launching asset purchase programmes much earlier.

Mr Draghi might become more explicit in setting a weaker euro as a policy objective. It is hard, however, to imagine him hyping share price rises as an achievement of the central bank, as happens on the other side of the Atlantic. Continental Europe does not have the same equity culture.

More crucially, eurozone QE would come at a different point in the market cycle. The US version was launched when share prices were near crisis lows. The Bank of Japan’s aggressive action followed decades of policy missteps.

In comparison, the launch of QE by the ECB would lack drama. “You don’t have the same degree of undervaluation – or anxiety and fear,” says Andrew Parry, chief executive of Hermes Sourcecap. Blue-chip eurozone stocks have already risen 75 per cent from their 2009 lows.

Still, by lowering longer-term interest rates and encouraging risk taking, QE would have positive effects on European markets. Equities would benefit from the expected boost to economic growth. “Global investors still feel Europe lacks support from the ECB. So QE would have an impact – and the US shows it can last some time,” says Emmanuel Cau, equity market strategist at JPMorgan.

Bundesbank fears

Debt markets would benefit directly. Partly because of opposition by Germany’s Bundesbank to any whiff of “monetary financing” – central bank funding of governments – and partly because the ECB’s aim would be to boost lending to job-creating southern eurozone businesses, its purchases are likely be focused largely on buying bank loans packaged up as “asset backed securities”.

But most debt market strategists argue that to have sufficient scale, eurozone QE would also have to include government bonds.

That could further lower yields, which move inversely with prices – although they have already fallen significantly this year and the US and Japanese experience suggests much of the movement comes ahead of implementation of QE.

Lower government borrowing costs would feed through into lower interest rates for businesses and consumers, pushing equities higher. But the share market “pop” that followed the unveiling of eurozone QE might be just that – a pop.

Will that matter? When the global financial crisis was at its most intense, “shock and awe” by central banks was needed to avoid catastrophe. Stock market rallies were part of the therapy.

The eurozone would test whether QE can stimulate real growth and consumer price inflation without necessarily driving financial asset prices sharply higher. If it did not work as well as a result, however, the ECB might ask: why bother?

ralph.atkins@ft.com

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