MacroScope

ECB to take the QE plunge this year…finally

February 26, 2014

Better late than never, right?

Despite the myriad political, legal and financial obstacles, the European Central Bank will this year take the plunge and start printing money, several years after its counterparts in the United States, Britain and Japan.

That’s the view of economists at BNP Paribas, one of the first major financial institutions to predict the ECB will use the printing press, the central bank weapon of last resort, to slay the dragon of deflation and steer the fragile economy away from recession once and for all:

Asset purchases are increasingly necessary in order for the ECB to meet its primary objective of maintaining price stability. Inflation in the euro area has persistently surprised to the downside, eroding the safety margin against deflation. „ Additional conventional policy easing will not deliver sufficient monetary accommodation for the price stability mandate to be met. Thus, the ECB will reluctantly have to follow other central banks into balance sheet expansion via asset purchases.

Annual inflation in the euro zone is currently running at 0.7 percent. That’s well below the ECB’s target of “below, but close to, 2% over the medium term” and according to BNP Paribas “is likely to remain that way for a long time.” Many economists think it will fall even further – Goldman Sachs is penciling in just 0.4% for March.

 

Against that backdrop, BNP Paribas reckons the ECB will buy between €300 and €500 billion of bonds in the initial phase of its asset purchase or “quantitative easing” programme. This will probably commence in the second half of this year and be spread across private sector and government debt.

The market impact of these purchases will be strong. Among the most dramatic consequences will be a fall in Spanish and Italian government borrowing costs of 60-80 basis points across the curve, and even further declines after QE starts. ƒ

BNP Paribas recognizes the challenges to its view. They include the complexities of the ECB having 24 policy-making members and the growing feeling that the desired economic effect will be minimal.

And then there are the legal hurdles, centering on whether such a policy would fall within the ECB’s mandate. Earlier this month Germany’s top court passed a decision on an as yet unused bond-buying programme called “Outright Monetary Transactions” (OMT) up to the European Court of Justice. But BNP Paribas doesn’t see this as an insurmountable hurdle:

It is important to stress, however, that even if the OMT programme is not operational, this would not preclude the ECB from asset purchases if it were to consider that failure to do so would jeopardize its adherence to its price stability mandate.

The history of the crisis shows that the euro zone adapts and at the last minute and does “whatever it takes”, to coin ECB President Mario Draghi’s now famous line, to avert disaster.

But the big question is whether this will be too little too late.  Large chunks of the euro zone are crippled by high unemployment, large debts and weak demand.  Aside from Germany, growth in the euro zone remains low even though it’s picking up.

Full-scale QE would be a gamble. But the ECB has very few cards left to play, so it may feel it’s a gamble it has to take.

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