With the US and UK now decisively engaged in quantitative easing, you have to ask, will the Eurozone be next?
The ECB has so far lagged behind other central banks in terms of expansionary fiscal and monetary policies, as the chart below, from UBS, shows.
So why the delay?
JP Morgan economist David Mackie puts it well:
We have made three observations regarding the ECB and unconventional monetary policy in recent months: first, legally and technically, the ECB has as much room to manoeuvre as any other central bank; second, its reluctance thus far has been partly because it has not believed that such policy is needed, and partly because of the risks created for future moral hazard and inflation; and third, in a relative sense, the ECB will never do as much as the Fed.
The second point, if none of the others, is changing.
Other countries’ QE policies have effectively transformed the ‘moral hazard’ of unconventional monetary policy into a virtual economic penalty for not engaging in the practice. At the same time, the ECB is gradually turning more bearish in its economic outlook, having leapfrogged consensus and delivered an especially pessimistic 2009 growth outlook earlier this month. Meanwhile European credit continues to stagnate despite a host of liquidity measures.
Quantitative easing could help that situation, reducing borrowing costs and lifting asset prices, thus encouraging banks to lend.
In fact, some have argued that the ECB is already engaged in a subtle form of QE. From the FT:
Some economists and analysts think that the ECB is pursuing a twin-pronged strategy that differentiates between a base rate that is important among the broader population and a financial interest rate that is the real driver of the cost of credit.
In January, the ECB widened the difference – known as the corridor – between the base rate and what it pays on cash deposits left with it by eurozone banks. This had the effect of cutting the deposit rate by 100bp when the base rate was cut by only 50bp.
At the same time, the central bank is supplying unlimited liquidity through its fixed-rate tenders, which has led to banks drawing down large volumes and recycling the cash as big deposits with the ECB. This in turn has dragged down the Eonia overnight interest rate closer to the deposit rate than the base rate.
Indeed, between September and early October last year, Eurozone commercial bank reserves expanded 83 per cent even as the official interest rate remained at 4.25 per cent (base money increased by 21 per cent) as the ECB expanded its normal repo operations with banks.
That may be unconventional monetary policy but it’s not quite QE.
The move helps fix some of the clogs in the credit system but it’s a policy that can be undertaken at any interest rate, because of the payment on interest reserves. In contrast, proper QE takes place when interest rates are at their minimum; when the central bank has concluded that conventional policy won’t be enough to fight a deflationary spiral.
So what’s the potential for Eurozone QE? Most definitely growing.
The credit crunch and economic situation aside, the ECB now has to contend with a rapidly appreciating Euro.
As the only major world currency not under some form of QE-induced stress, the Euro is a natural target for those seeking to escape the spectre of inflation and competitive devaluation elsewhere. But, a stronger Euro is not a good thing to have when your manufacturing base is already collapsing. Bad for exporters, bad for the economy. Bad for Europe.
Helicopter Jean-Claude, here we come.
Related links:
ECB enters ‘non-standard’ policy – FT