22 January 2015

The key points and details of the announcement can be found here, so we won’t rehash them. But there are plenty of interesting points to consider.

What will the economic impact of this ECB QE be?

  • From March, the ECB will make monthly purchases worth €60bn of public and private sector assets – this means government bonds, EU institutions (European Investment Bank for example), Asset-Backed Securities (ABS) and covered bonds. It does not seem to include corporate bonds. The purchases will run up to at least September 2016, totalling €1.08 trillion. As the graph below shows, this will take the ECB balance sheet over its previous peak and will push it beyond the previous target of around €3 trillion.Open_Europe_Graph1_ECB_150122 itemprop=
  • As predicted, the purchases will be shared out according to the ECB’s capital key. Under the current timeline, this means that the ECB could purchase up to 17.4% of the outstanding long-term central government debt in the Eurozone (these figures are upper thresholds, as in reality not all the purchases will go into government bonds).
  • As the chart below shows, a huge amount of Germany’s debt market could be purchased – this will drive prices even higher. Spain and Portugal could also benefit quite significantly, with 19% and 24% of the central government debt possibly being purchased. However, France and Italy will not see as much benefit. Furthermore, in the large majority of cases (and overall) the amount purchased will not come close to the 27.5% and 21% of debt markets purchased in UK and US.Open_Europe_Graph2_ECB_1501221 itemprop=
  • Notably, countries such as Estonia and Latvia will not really be able to make any purchases since the level of outstanding government debt is close to zero. Certain countries will also see their purchases limited, to make sure they do not own more than 33% of their debt market.
  • While this package is slightly bigger than expected, and vaguely open-ended, we still do not believe it will have a sizeable impact on the real economy or inflation. As we noted in our report early this week, the overreliance on bank lending means that this money could well get trapped in the banking system – despite ECB President Mario Draghi’s hope that money will flow across borders.
  • Draghi specifically mentioned the ‘portfolio rebalancing channel’ and the ‘signalling channel’ as avenues through which QE could work. The former is possible, although rebalancing into what remains the question. The hope would be the corporate bond market. There are signs this happened in the US and UK. However, the corporate bond market in the Eurozone is only a sixth the size of the market in the US. Corporate bonds currently account for just 7% of institutional investors portfolio in the Eurozone, compared to 48% in government bonds. These practices are brought about by more than just liquidity issues, but fundamental regulatory and risk balancing issues. Changing this approach is a huge ask even for a programme of this size.
  • The signalling channel is important, and as the sharp moves in the euro/US dollar exchange rate today show, Draghi has managed to surprise the market somewhat. However, this may also be hampered by the risk-sharing approach. As we noted on our blog here, the risk sharing itself is unlikely to undermine the economic impact since the practical effect is the same as if the ECB took entire responsibility.
  • It seems likely that a large amount of this money will flow out of the Eurozone due to the ongoing economic malaise, poor business climate and low returns. This will further weaken the euro, which could help boost exports. This is of course far from guarantee as the experience of Japan shows since 2012 – its currency has weakened massively but exports have barely grown. At some point it could also start hampering the level of investment in the Eurozone economy.
  • Markets will undoubtedly be buoyed, however, this has been the case for the past two years and yet this is yet to trickle through to the real economy. We noted in our paper that this could well be down to the lower level of direct household exposure to financial assets in the Eurozone.

What about Greece?

  • The position of Greece in all this is a bit uncertain. The technical points of the programme highlight that for any country with bonds below investment grade, there must be a special exemption applying and the country must be in a bailout programme. Any purchases will also be put on hold while the programme is being reviewed and will not be started unless the review is completed – an interesting sign of the ECB trying to impose some level of conditionality on the more risky purchases it makes.
  • Furthermore, the ECB still owns around €20bn of Greece’s €67bn in outstanding bonds. As Draghi pointed out, it would probably have to wait for some of these to expire in July/August before it could even consider purchasing any more – as otherwise it would own more than 33% of the market. Even then, it will be operating close to threshold.
  • Overall, it seems difficult for Greece to gain much from this operation, it is contingent on a number of negotiations over the collateral exemption and the bailout extension but also hit by some practical barriers due to the small size of the bond market following its previous debt restructuring.

Does the programme raise any legal questions?

  • There will undoubtedly be a legal challenge in Germany against this programme. However, the steps taken may have mitigated the change of this succeeding.
  • The risk-sharing approach limits the concerns about fiscal underwriting, since now National Central Banks (NCBs) will be largely responsible for the risks of purchases. The ECB will keep 20% of the risk – 12% via underwriting and 8% from direct holdings of assets on its balance sheet.
  • Importantly, Draghi said the ECB Governing Council had been “unanimous in stating that the asset purchase programme is a true monetary policy tool in a legal sense.” This suggests that the Bundesbank has confirmed it will support the legality of the programme. This is opposed to its position on Outright Monetary Transactions (OMT) where it actively argued the case that the programme is illegal.
  • One point which could cause problems is the fact that the programme is partially open-ended. The ECB intends to end it in September 2016, but promised to go on as long as is needed to boost inflation back towards its target. This could create concerns about unlimited interventions. However, in practice, the ECB’s promise to split purchases according to its capital key and not purchase any more than 33% of any given debt market do put some kind of a limit on the programme, albeit a vague one.
  • Draghi also stressed that the ECB is the “sole decision maker” despite risks being placed largely with the NCBs. This suggests that, now the decision has been made, no NCB can rebel and that they will be required to make the purchases. This could lead to some potential conflict, especially given the size of purchases require in Germany.
  • It will be some time until we know the outcome of any court case at the German Constitutional Court. However, with risks largely being located at the NCB it may be easier for the GCC to remove the Bundesbank from any operation. That said, the point above means that this could be seen as undermining the policy as a whole, potentially setting up another clash between the ECB and GCC.

Could it be politically explosive?

  • As with the legal points, the structure of the programme may reduce the political difficulties somewhat. However, as the virulent German response we detailed on our blog shows, this is far from sufficient to appease everyone involved. That said, it seems the Bundesbank will not lead any public legal challenge against it and that the German government is on board, this should limit some of the political fallout.
  • Greece and the potential SYRIZA government could also raise concerns about de facto being left out. This could create difficulties in the upcoming negotiations, though, of course, it could also provide an incentive to create a deal.

As a package, the total amount is higher than most expected as are the monthly flow of purchases. This will buoy markets. The programme may help instil a more positive mindset and lower the exchange rate to boost exports. However, this is unlikely to be lasting. In the end, the ball remains firmly in the court of national Eurozone leaders. As Draghi himself suggested, unless they can significantly improve the business climate and enhance structural reforms (in some of the largest members) as well as tackling the institutional problems, the impact of ECB QE could well be limited.