European Central Bank (ECB) president Mario Draghi has done what many in the markets had hoped for, and announced a massive package of QE of over €1 trillion – promising more if need be. This is much bigger than had generally been expected, indicating Draghi’s determination to deal decisively with the Eurozone’s deflation problem. If he had stuck to the widely touted €500bn figure, QE could well have been considered a damp squib, criticised as being too little too late and giving fuel to the numerous critics who doubt QE’s effectiveness.
Indeed, the markets had pretty much priced QE in, and anything around €500bn would have made very little difference to already very low yields. These had dropped sharply in anticipation, even among hugely indebted countries like Italy, Spain and Portugal. If the ECB had not intervened, the markets would have gone into reverse.
But the size of the proposed intervention – €60bn a month from March 2015 until at least September 2016 – indicates that the ECB really worries about deflation in Europe, which can seriously undermine confidence if it persists. Prices last month in the Eurozone fell by 0.2 per cent year on year. And although core inflation (when factors such as the sharp drop in oil and other commodity prices are excluded) was 0.8 per cent, this is still way below the 2 per cent ECB target. In places like Greece, inflation of -2 per cent has been witnessed for many months.
Draghi also managed to negotiate a reasonable compromise for the bond buying spree. There is an element of risk sharing, as the ECB will guarantee 20 per cent of the additional debt, while the remaining 80 per cent will be done by member state central banks, approximately reflecting the relative size of their GDP in the Eurozone. That is an extra boost to the markets and will help improve confidence that the Eurozone is serious about tackling poor growth and deflation.
Yields fell further immediately after the announcement – even in Greece, despite the fact that the country, along with Cyprus, will not benefit from asset purchases at this stage, since debt has to be investment grade to be included. Lower long-term rates mean more encouragement for investment and growth.
There is no doubt that the Eurozone economy is in desperate need of a stimulus. Forecasts have been continuously downgraded and growth may not be much above 1 per cent in 2015. Unemployment has been stuck at over 11 per cent and is much higher in places like Spain and Greece (at 24 per cent and 26 per cent respectively). Youth unemployment in a number of countries is above 50 per cent.
The ECB’s actions make it clear that interest rates will stay low for at least the next 18 months. Further, the euro declined on the QE news and, of course, that is another of the intervention’s aims. A weaker euro is good for inflation and exports, and that should help.
QE on its own will not sort all the Eurozone’s problems; the fiscal side needs to be looked at in parallel. But the good news is that we are on the verge of a new look at how austerity and reforms are forced on countries.
In many cases, fiscal consolidation programmes have proved too harsh for countries to bear. Greece is a case in point, and anti-austerity radical left Syriza might well be the biggest party after elections this weekend. Whoever wins will need to renegotiate the debt and give the Greeks hope. If not, despite Draghi’s massive support, worries about a possible “Grexit” – indeed about the continuing existence of the euro – will remain.