Crunch time

January 22, 2015

ECB President Draghi addresses during ECB news conference in Frankfurt

The biggest policy decision of the year? The first U.S. interest rate rise may trump it whenever it comes and the Swiss National Bank has set the bar pretty high but an awful lot hangs on what the European Central Bank comes up with today.

We know that the Executive Board of the ECB has proposed government bond purchases with 50 billion euros of new money each month with the programme beginning in March. But there is scope for the full Governing Council to change things before the afternoon announcement.

There are still significant unknowns (to channel Donald Rumsfeld). The Wall Street Journal said the scheme would run for a minimum of a year while Bloomberg said it could go through 2016. That would make a potential difference between 600 billion euros and 1.05 trillion euros in total.

That’s a gulf as far as financial markets are concerned and whichever it is – if it is either of those – will dictate market reaction.

There are other constraints as well. The euro central bank has no problem justifying action. It is mandated to deliver inflation close to 2 percent whereas it has just turned negative and is likely to fall further given the precipitous oil price drop. But German concerns about risk-sharing have to be taken into account.

Sources have told Reuters the ECB may adopt a hybrid approach; buying debt and sharing some of the risk across the euro zone while national central banks make separate purchases of their own. If potential losses are borne at a national level, the whole euro zone concept of risk sharing would be compromised and countries with already high debts could find themselves with further liabilities.

That may go some way to meet German worries but concerns others. Irish finance minister Michael Noonan warned that a watered-down approach would render QE ineffective.

What is more, an awful lot of this is now priced in so whether government bond costs and the euro are driven lower – two things which could help boost the euro zone economy – remains to be seen.

Lastly, we don’t yet know whether bailout countries Greece and Cyprus will be included in the programme.

German reaction to whatever transpires will be key in shaping expectations for how durable the scheme will be. Angela Merkel, hot-footing it from Davos where she speaks at about the same time as Draghi in Frankfurt, will hold talks with Italy’s Matteo Renzi in Florence later in the day.

Merkel wants no excuse for euro zone governments to go easy on debt-cutting and economic reforms. Renzi, whose economy is still in recession, takes a different view, telling delegates in Davos yesterday that Europe was currently “not in an economically correct direction” and that he hoped the ECB would help set a new tone.

These are febrile times. The SNB was the real stunner but since then Denmark and Canada have been forced into impromptu interest rate cuts, the former to hold its currency peg to the euro, the latter on concerns about the plunge in the price of oil. Brazil delivered a more anticipated rate hike to curb too high inflation and the two (of nine) British rate setters who had been voting for tighter policy have now dropped their call.

Poland has had to scramble to deal with a glut of Swiss franc mortgages held by its citizens. Denmark is very likely to cut interest rates further into negative territory after the ECB meeting, unless Draghi has underwhelmed markets and the euro heads higher.

Ukrainian President Petro Poroshenko accused Russia of sending 9,000 troops to back separatist rebels in the east of his country. Moscow issued a denial but NATO said the amount of heavy military equipment used by Russian troops in eastern Ukraine had increased.

Kiev is close to bankruptcy and awaiting a $4 billion-plus tranche of money from the IMF. Christine Lagarde said it had asked for further funding via a multi-year agreement and said Ukraine would have to make broad and deep economic reforms in return for any deal.

The foreign ministers of Russia, Ukraine, Germany and France held talks last night with Berlin declaring on agreement on establishing security zones between pro-Russian fighters and Kiev’s forces.

The British government will publish a draft law underpinning a big transfer of powers to Scotland, keeping a promise it gave to Scots to encourage them to reject independence. The law, to be enacted after a May UK election whoever wins, will further dismantle Britain’s centralised system of government. It has already spurred demands for similar powers from politicians in England, Wales and Northern Ireland.

Representatives of opponents of Islamic State meet in London. Iraq’s prime minister is attending as are U.S. Secretary of State John Kerry and British Foreign Secretary Philip Hammond.

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