ECB to fill in the QE gaps

March 5, 2015

ECB President Draghi arrives to take part in a plenary debate on the ECB's Annual Report 2013 at the EU Parliament in Brussels

The European Central Bank is holding its monthly meeting – an offsite gathering in Cyprus – and is about to commence its quantitative easing bond-buying programme.

We can expect to get a precise start date and some more details on what central bankers like to call “modalities” – whether national central banks will only buy their own country’s debt, what tenure of bonds will be bought and whether those already boasting negative yields will be in play.

The ECB has convinced only slightly more than half of 83 economists polled by Reuters that its money printing will be successful in bringing euro zone inflation back up to its target of close to but below two percent.

Inflation headed up nearer to zero last month and the real economy data has by and large been coming in on the strong side of expectations.

Economists point to the greater discretionary income given to consumers by a dramatic fall in energy prices over the past six months and the prospect of the ECB pumping more than 1 trillion euros of new money into the euro economy over the next 18 months.

Alongside everything else it has to consider, the ECB will publish new staff forecasts for growth and inflation. The question is whether it is now underestimating future growth, having spent two years cutting its forecasts to catch up with a grimmer reality.

It is expected to raise growth predictions but cut those for inflation – already down at -0.3 percent — this year as the full impact of a halving of oil prices is factored in.

The bond market has certainly reacted in anticipation of QE — investors actually pay for the privilege of lending to Germany for five years. Yields in Italy, Spain and Portugal dropped to record lows this week.

ECB policymakers hope their efforts will push the euro still lower, thereby lifting imported inflation and boosting exports. But it remains to be seen whether banks will use the money to lend to businesses and households although there are signs of life there too.

There is also a question of whether the banks will be willing to hand over government bonds they hold to the ECB even in return for new money. Banks, pension funds and insurers are hoarding government bonds for regulatory and accounting reasons and may be loath to give up their euro debt holdings.

Greece will cast a long shadow over the ECB which is determined that decisions about the country’s future are taken first and foremost by euro zone politicians.

It could agree to accept Greek bonds for regular ECB funding operations of banks once more but probably not this soon. ECB chief Mario Draghi said last week that could happen only when the conditions for a successful completion of the bailout programme are in place. With both the ECB and IMF saying the Greek reform plan is light on detail, it’s unlikely to be able to reach that judgment yet.

Aside from its struggle to agree a third bailout programme over the next four months, Greece faces acute short-term funding problems.

Its new government insists it is in no danger of running out of money but the methods it may have to deploy smack of short-term gain for longer-term pain. Debt officials told us the plan is to tap into the cash reserves of pension funds and public sector entities through repo transactions as it scrambles to cover its funding needs this month.

The Bank of England will also deliver a policy decision and it will be “no change”. Thirty-three of 61 economists polled by Reuters expected the Bank to hike rates by the fourth quarter of this year, but 28 now predict they will wait until early 2016 at least. Growth is strong and unemployment dropping but the near total absence of inflation gives the Bank no urgency to act.

Italian premier Matteo Renzi is in Moscow for talks with Vladimir Putin. Italy has tended to take a more emollient line than many of its EU partners, not least because it is heavily reliant on Russian gas.

The Group of Seven leading economic powers praised the Ukrainian government’s determination to reform the economy, saying a new draft budget should put it on track for an IMF-led bailout.

Britain’s David Cameron may just have shifted the electoral odds.

Last night, he ruled out a series of televised debates in the run up the May 7 election and instead agreed to only one featuring six other party leaders. The cacophony that will result will render the event impossible for any one leader to “win”.

Labour and the Conservatives are neck-and-neck in the polls but in terms of personal ratings, Cameron far outstrips opposition Labour leader Ed Miliband. A head-to-head debate on prime time TV between the two of them would have offered Miliband his best chance of changing public perceptions. It looks like he won’t get it. Cameron will be accused of running scared but that may well prove to be a price worth paying.

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