The ECB has finally opted to go for ‘full’ quantitative easing and will buy the government bonds of eurozone member states to the tune of €60 billion a month up to September 2016 and beyond (a total €1.1 trillion or 11.8% of eurozone GDP), until its inflation target of close to a 2% annual rate is met. In terms of flow (0.6% of GDP a month) this is greater in size than any of the US QE programmes.
The €60 billion encompasses private and public sector euro securities (but does not extend to corporate bonds) to be allocated across markets according to the weighting of each state. ECB and national central bank purchases will rank pari passu with private sector investors. So if, eventually, there are losses on any of these purchases – heaven forbid – the ECB will take as big as hit as private sector bondholders.
The fact that only 20% of the ECB purchases would be at mutual risk for the whole of the Eurosystem, with the rest falling on the shoulders of each national central bank, is not really a problem for the effectiveness of the QE plan, although it does not bode well for the future of fiscal union in the eurozone. But it was necessary to keep the Germans on board for a programme of bond purchases of southern European governments, something they find difficult to swallow, especially with the rise of eurosceptic sentiments inside Germany.
But, given all the other pluses of what was announced, markets have ignored this rather ugly fly in the ointment and the euro has fallen, bond yields have dropped and inflation expectations have risen – exactly what the ECB wanted.
I am now convinced that the euro is heading towards parity with the US dollar. This will make eurozone exporters very competitive in world markets and dollar-earning companies will find rich rewards on their profit and loss sheets. That suggests European equities will do well this year.
The eurozone economy is at a turning point and the likelihood is that we will get better growth and continuing low inflation, alongside QE. And the falling oil price is another helper for a recovery in the eurozone economy as households spend more and corporations see costs fall. QE buying will deliver further falls in government bond yields, keeping mortgage rates at all-time lows. And for the first time since the global financial crash, the demand for loans from consumers, householders and businesses has moved into positive territory.
But it is not good news for those that cannot devalue their currencies along with the euro. The Swiss central bank gave up the ghost and admitted defeat in trying to stay with the euro’s fall. Swiss exporters now face a terrible time. Down the road, US companies will also face problems. And the likely attempt of the Federal Reserve to raise interest rates later this year will increase the upward pressure on the dollar.
As all important currencies try to conduct a race to the bottom, I’d consider buying gold as a safe currency alternative. And a rising US dollar will increase pressure on central banks in emerging economies to cut interest rates and weaken their currencies. It would probably make sense for China to re-jig its exchange rate management by shifting to a trade-weighted basket of currencies to anchor the yuan against while implementing a one-off 6% or so devaluation against the US dollar.
The ECB has gone for broke in trying to kick-start the eurozone economy. This is the last bazooka in its armoury of credit injections. As ECB president says, the central bank can set the environment for expansion by providing the funds. But while you can lead a horse to water, you cannot make it drink. Europe’s businesses and households must start spending this largesse in new investment and new purchases. Draghi wants governments to introduce structural reforms to make labour and services sector markets more efficient so that increased spending leads to faster economic growth. That is the next challenge to Europe’s recovery in 2015.