Europe’s QE is sterilised and sensitive

Here’s something intriguing about the European Central Bank’s overnight statement.

It’s being lauded as European quantitative easing by some market commentators — but there’s a key difference to the kind of government bond-buying that has been carried out in the UK, US and Japan. The ECB plans to sterilise its purchases of debt; thereby divorcing the monetary aspect from the credit aspect.

This old series of charts showing US QE, from Bank of America, should show the difference:

By sterilising — selling assets such as German bunds — the ECB should be able to limit the effect of the bond purchases on Europe’s monetary base while simultaneously supporting Club Med debt.

It’s very reminiscent of what the Bank did for covered bonds in 2009.

But even then the topic of sterilisation — with its QE and inflationary undertones — was a very sensitive one for ECB president Jean-Claude Trichet. To wit, this May 2009 press conference:

Question: Firstly a question on the covered bonds. Can you tell us how you came to the figure of around €60 billion? . . . And secondly how are you going to pay for this? Will the purchase be sterilised or can we write that you are going to be printing money?

Trichet: . . . With regard to sterilisation, it is included in the question of the exit strategy. I mentioned in the introductory remarks that we consider this issue as absolutely decisive. We have to be up to the present exceptional circumstances. And I don’t want to repeat all the areas where we were the first central bank to act and to take bold decisions. Whether it was the longer-term refinancing of commercial banks, or at the beginning of the turmoil being the most forthcoming central bank as regards its collateral framework, or when we had to take bold action in particular at the very beginning of the turbulence on 9 August 2007. As regards today’s decision taking into account all elements we considered that we could and we should go beyond what had been until now our main channel for enhanced credit support mainly by the refinancing of commercial banks which has, by the way, produced important results. I would like to mention en passant the figures which show that thanks to the decisions we have taken so far – they don’t incorporate of course the new decision taken today – our one-year money market has lower interest rates than in the sister central banks’ money markets. This is also the case at least with one sister central bank for the six- and the three-month money market interest rates. One has to take into account everything, and in particular our handling of our own money market with our full allotment, fixed interest rates procedure, the very forthcoming attitude we have as regards longer-term refinancing, which has even been enlarged today and the collateral that we accept. That being said the Governing Council considers sterilisation and the exit strategy absolutely essential to maintain the maximum amount of credibility in the medium and long term. The public debate emerging on whether or not some central banks are paving the way at the global level for future inflation is extraordinarily counterproductive . . .

And again in June:

Question: I have a few questions on the details of the covered bonds plans: Will you sterilise the purchases? Also, were there calls today for expanding the €60 billion to a higher amount? . . .

Trichet: . . . As regards your questions on the programme for the purchase of covered bonds, we decided on €60 billion and no other decision has been taken at this stage. We will carry out the programme, which is explained in the press release that you have been given. I will not comment on the discussions that took place. As always, there were discussions. What counts is what was decided unanimously by the Governing Council. What counts is today’s decision which we consider was – and is – the appropriate decision, taking into account all circumstances. And, we don’t expect in any respect that it will hamper our attachment to the delivery of price stability in line with our definition. We consider all this to be fully in line with our monetary policy strategy. I have repeated several times that we are inflexibly attached to the solid anchoring of inflationary expectations in line with our definition of price stability, which is the main asset that we have in the present circumstances.

Two simple questions eliciting almost 500 words of defensive central bank-speak in reply.

And the inflationary-aspect of the the ECB’s new bond-buying programme is likely to generate even more defensiveness — despite the more explicit sterilisation. It’s not quite QE, but it is controversial.

JP Morgan’s David Mackie put it well on Monday:

Of all the interventions announced over the weekend, the most dramatic is the ECB’s decision to engage in outright purchases of government debt, something which they didn’t do even in the depths of the financial crisis. It is clearly inappropriate for any central bank to provide ongoing monetary financing for a sovereign which is no longer able to fund itself in the capital markets due to concerns about its solvency. That is the road to inflation, or even hyper inflation, which is why direct monetary financing of fiscal deficits is explicitly forbidden in the Lisbon Treaty. However, the central bank does have a responsibility to ensure adequate liquidity in the banking system and thereby make a contribution to the broader financial stability of the system as a whole. The motivation of ensuring financial stability is critical to the ECB in taking this decision, as is the commitment from Euro area governments that they will make the appropriate fiscal adjustment over time.

When’s the next press conference?

Related links:
Why the ECB is a good bank with rubbish assets – FT Alphaville

Copyright The Financial Times Limited 2019. All rights reserved. You may share using our article tools. Please don't cut articles from and redistribute by email or post to the web.

Read next:

Read next:

FT Alpha Tweets