Whatever it takes or whatever it can get away with?

January 14, 2015

ECB President Draghi addresses during ECB news conference in Frankfurt

Markets are beginning to ponder just how definitive the European Central Bank may be next week in launching quantitative easing. One reason is today’s ruling at the European Court of Justice.

The ECJ’s advocate general will give an opinion on whether the ECB’s earlier bond-buying scheme, which has never been used, is legal. It will send an important signal as to how much freedom the ECB has with its planned government bond-buying programme with new money.

An outright rejection of the OMT scheme is highly unlikely, but the devil will be in the detail of the ruling.

The advocate general only offers an opinion to the court, but its judges usually follow the advice. The case was referred by the German Constitutional Court, which believed that the OMT bond programme may violate a taboo on the central bank financing governments.

The ECB will not want to give room for a similar challenge to any QE scheme, which suggests it must buy the bonds of all its member states across the capital key.

The exceptions may be Greece and Cyprus, which remain under EU/IMF bailouts. Some in Germany would certainly look askance at buying the bonds of a country which could soon be led by the left-wing Syriza party, which has pledged to renegotiate Greece’s towering debts and put an end to austerity.

Given Greek elections three days after the ECB’s policy meeting throw a big dose of uncertainty into the mix, it is quite possible that Mario Draghi will address his monthly news conference on Jan. 22 and give a green light while saying that the details, and launch, will come later.

We know the ECB is looking at various options, which are not necessarily mutually exclusive: Buying government bonds itself in a quantity proportionate to each member state’s shareholding in the central bank; Buying only investment grade government bonds (that would exclude Greece and Cyprus from the programme); Making national central banks do the buying, meaning that the risk would remain with the country, not the ECB.

Our latest information is that the ECB may adopt a hybrid approach with it buying debt and sharing some of the risk across the euro zone while national central banks make separate purchases of their own – a compromise that would bring into question the authority of the euro zone central bank is if it has to partially delegate its ultimate policy gambit.

The programme may be limited in size to 500 billion euros.

The ECB is trying to build as robust a scheme as possible while meeting German concerns about pooling risk. On the face of it, with inflation now negative in the euro zone, the ECB has ample cover to do whatever it wants (whatever it takes?) to meet its price stability target.

But that may not be the way it pans out. Any programme that limits the size of bond-buying will disappoint the markets.

After UK inflation dropped to a 14-year low of 0.5 percent, government ministers and the Bank of England rushed out to say it was a good thing, in that it would boost purchasing power.

Governor Mark Carney said he still expected interest rates to “normalize” in the foreseeable future (although maybe now a little bit later) and that the Bank had the tools to deal with any deflationary threat. He also ruled out more money printing.
Deflation probably won’t grip a robustly growing British economy but with rates close to zero and QE apparently not an option, what are those tools precisely?

Carney is at parliament’s Treasury Committee today and finance minister George Osborne gives a speech to the Royal Economic Society.

The World Economic Forum will publish its global risks report ahead of the annual gathering of great and good in Davos next week. Last night, the World Bank lowered its global growth forecast for this year and next due to poor prospects in the euro zone, Japan and some major emerging economies. A plunge in the price of copper is also a poor harbinger and oil continues to head south at a rapid rate.

Russia’s finance ministry said it sold $154 million on the forex market on Monday in an attempt to stabilize the rouble. It has opened 1.6 percent lower against the dollar this morning. Moscow says it is expecting its credit rating to be downgraded to junk and inflation to peak as high as 17 percent in a few months.

Any thoughts of a durable Ukraine ceasefire appear to have been dashed after a passenger bus came under heavy fire in eastern Ukraine, killing at least 11 people, and fighting intensified around the airport in the city of Donetsk.

The five nations that make up the world’s leading intelligence-sharing network will meet in London next month to confer in the wake of the Paris attacks, Canada said on Tuesday. That was a rare admission. Members of the so-called Five Eyes – the United States, Australia, Canada, Britain and New Zealand – rarely publicise their activities.


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