ECB's €1tn QE plan: Economists surprised, but leaders warn on reforms

Chris Papadopoullos
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Mario Draghi went further than many investors had expected

European politicians have been warned not to ease off on economic reforms now that billions of euros worth of quantitative easing (QE) has been launched, while economists have been surprised by its scope.

“Regardless of what the ECB [European Central Bank] does,” Angela Merkel said in Davos yesterday, “it should not obscure the fact that the real growth impulses must come from conditions set by the politicians.”
Sigmar Gabriel, Germany’s economy minister said: “European politicians should not leave to the ECB alone the task of stimulating growth and employment.”
ECB chief Mario Draghi also warned that QE by itself would need to be complemented by “the determined implementation of product and labour market reforms as well as actions to improve the business environment for firms.”
George Osborne aired similar concerns. “I think this is welcome action from the ECB but action from a central bank is necessary but not sufficient for a European recovery,” he told Bloomberg. “We want see this accompanied by clear plans to make the European continent more competitive to back business in europe.”
Economists were surprised by the scope of the programme. The ECB will buy debt with a maturity of between two and 30 years. The maturity is the time until the debt has to be fully repaid. There are various advantages to buying debt with a longer maturity.
“Perhaps the most important “surprise” is that QE will target paper[bonds] from two years all the way out to 30 years,” said Marchel Alexandrovich from investment bank Jefferies. Alexandrovich notes the programme’s similarity to that done in the UK and US.
It is also unlikely the ECB will focus their purchases at the shorter end of the two to 30 year maturity range. Richard Batley, an economist at Lombard Street Research explains that when the UK did QE it had to buy debt of varying maturities as it was trying to avoid distorting the market. “The ECB will have the same objective [as the UK] and so I would expect a similar result of purchases being broadly proportionate to outstandings,” Batley told City A.M.
Buying assets from non-banks can help as money goes to non-banks as well as banks. Tim Congdon, chief executive of International Monetary Research notes that: “On the whole, banks do not own long-dated government securities, because of their price volatility.”
“The QE programme just announced seems to me to be sensible and appropriate, and well-calibrated to the Eurozone’s current predicament. It should contribute to a discernible improvement in demand and output growth.”



■ The European Central Bank is printing €60bn per month to inject into Eurozone bonds. This starts in March and will go on until at least September of 2016, but possibly longer if the central bank wants it to. That means at least €1.1bn in total.
■ Investment grade government bonds are the main target, but the ECB is also going to buy asset-backed securities and covered bonds in a bid to cut interest rates for companies. For instance, 12 per cent of the bonds bought will be those issued by pan-European institutions. However, it is not buying straightforward corporate bonds, or higher-risk junk-rated debts.
■ The ECB does not want to hold more than 33 per cent of all the bonds issued by any one government. That rules out Greece for now, as the central bank had already bought the debt as part of the bailout packages. There is another limit, as the ECB only wants to use this scheme to buy investment grade bonds, to limit the risks to which it is exposed. The troubled state’s government has a junk credit rating of single-B with Standard and Poors. Greek bond yields still fell as interest rates dropped across the Eurozone, and there is still a chance it could one day be upgraded again, letting the ECB buy its bonds.
■ Each country’s national central bank will be responsible for buying the bonds of that nation’s government. Those purchases will be co-ordinated by the ECB to make sure no one country buys more than its fair share. If that government defaults, then the national central bank will be responsible for bearing losses on those bonds. For pan-European institutions, plus another eight per cent of the overall package, the ECB will bear the losses. That means 80 per cent of the bonds will be the responsibility of governments, and 20 per cent will fall to the ECB.
■ The ECB has come to quantitative easing gradually, and made sure it surprised markets with the scale of the plan. At the start of the year banks expected €500bn of money printing. Gradually the ECB managed expectations up to as much as €1 trillion, before surprising again with €1.1 trillion or more.

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