Analysis: ECB in limbo, boxed in by own plans, German opposition to QE

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Paul Carrel and Eva Taylor Frankfurt

THE EUROPEAN Central Bank (ECB) is in a policy no man’s land, bombarded by news of a stagnating euro zone economy but hesitant to move forward with new stimulus until measures it loaded in June have ignited.

After the ECB cut rates in June and promised banks cheap long-term loans from September, about all that is left is printing money to buy bonds – so-called quantitative easing (QE).

But there are tricky practical and political barriers in the ECB’s way: it is boxed in by its own plans, and still faces strong opposition from economic power Germany to any such monetary leniency.

Already deployed by other central banks, QE could be used to pump money into the euro zone with a view to stoking growth and staving off deflation, which has already gripped countries in the bloc’s south. At just 0.4 percent, euro zone inflation is in what the ECB considers a “danger zone”. Economic growth, meanwhile, ground to a halt in the second quarter even before the bloc has started to feel the impact of sanctions on and by Russia over Ukraine.

Yet the ECB may be in a wait-and-see mode for some time, until the measures it announced in June kick in. The first tranche of loans it is offering banks to stimulate lending, called targeted longer-term refinancing operations (TLTROs), is not available until September 18, with a second shot in December.

“What is happening in geopolitics is tilting the balance toward having to implement further stimulus,” Andrew Bosomworth, a portfolio manager at Pimco, said.

“But I think there are a few things in the pipeline on the positive side that we can point to as well, so we’d put a 50-50 chance on QE right now, which brings me to the conclusion that the ECB is in observe-and-analyse mode for now.”

On the plus side, while the economy had no growth in the second quarter, euro zone banks did ease lending terms for firms for the first time since the start of the financial crisis.

And as well as TLTROs, the ECB is also intensifying preparations to buy asset-backed securities, which are created by banks pooling loans into an interest-bearing bond that is sold to raise funds.

The asset-backed securities market has not recovered following the global financial crisis, but the ECB hopes that by supporting this segment it can get credit to the smaller firms that make up the backbone of the euro zone economy.

Any asset-backed securities plan is likely to be small, but the ECB expects take-up of e450 billion (R6.4 trillion) to e850bn for the TLTROs, potentially more than the total annual gross domestic product of the Netherlands.

But despite the queued-up stimulus, improving credit conditions and the prospect of more robust banking thanks to upcoming health checks, France and governments further south want the ECB to do more to buoy their economies, which they have been unable, or unwilling, to shape up.

“I am convinced that more can be done and I’m also convinced that the ECB is getting ready to do more,” Italian Economy Minister Pier Carlo Padoan said at the weekend.

Indeed, a Reuters poll of euro money market traders gives a 50 percent chance that the ECB will resort to QE-style asset purchases to boost inflation in the coming year.

But waiting for evidence that what it has done is working is only part of the ECB’s QE dilemma. Some policymakers believe QE is inappropriate; others are not sure it would work anyway.

There is also the issue of what to buy. In the US, where the economy is based on capital markets, Federal Reserve purchases of US treasuries and mortgage-backed bonds had an impact across asset prices, holding down borrowing costs.

Padoan acknowledged this: “Quantitative easing has worked well in the US… but of course the underlying economic structure of the US economy is largely different from the still-fragmented euro area.” – Reuters


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