Will ECB end QE?
October 25, 2017
Since March 2015, the European Central Bank (ECB) has been buying government bonds (also known as 'sovereign' bonds) as well as some corporate bonds in huge volumes, at a rate of 60 billion a euros month. The declared aim of this practice, often called "quantitative easing" (QE) in the jargon of central bankers and economists, has been to stimulate inflation and growth in the euro area.
Critics from Germany in particular saw QE as a hidden way for the ECB to fund European national governments — which is illegal under the 'Maastricht treaty,' the 1992 statute that established the rules governing European monetary union.
Read more: Deutsche Bank CEO warns of asset bubbles amid QE
Some of the critics went to the German Federal Constitutional Court in Karlsruhe to attempt to block the ECB's bond-buying program, but the judges in Karlsruhe and the European Court of Justice both ruled in favor of the ECB, subject to the proviso that the monetary authority must be bound by a self-imposed limitation specifying that the ECB should not buy more than one-third of the bonds of individual countries, in order not to become the main creditor of eurozone nations.
The one-third limit is fast approaching: if the ECB keeps buying government bonds at the current rate, it will own more than one-third of German federal bonds by the summer of 2018.
"That's why the ECB on Thursday likely won't discuss whether it will reduce the purchase of sovereign bonds in the coming year, but rather, to what extent it will do so," Commerzbank chief economist Jörg Krämer wrote in an analysis released this week.
"We're expecting a clear entry into an exit from bond purchases, and we expect the ECB's bond purchases to fall to 20 billion euros a month," said Uwe Burkert, Chief Economist of LBBW, another German bank.
This optimistic prediction is based on two factors: "First, the political situation is quite stable, and second, economic development in the eurozone is robust, so the ECB doesn't need to take into account a recession in any country," Burkert said in an interview with DW.
Read more: Rome urges ECB to be cautious in reducing eurozone bad loans
Jens Kramer, an analyst at Nord LB, another German bank, takes a similar view. However, he expects the ECB's bond purchases to decline somewhat less, down to 30 billion euros — half the current rate — by January. This compromise would suffice to appease German members of the ECB Council, who have been skeptical of the central bank's massive bond-buying program.
From the middle of next year, in Krämer's view, the ECB might ease back bond purchases to ten billion euros a month: "Then no-one would have been caught wrong-footed, and markets would have time to adjust to an end of the ECB's quantitative easing program in the autumn of 2018," Krämer said.
Uwe Burkert from LBBW doesn't expect any significant resistance from the southern European countries, the main beneficiaries of the QE program, to a reduction in its scope. "If the ECB signals to financial markets that it sees the situation as sufficiently solid and stable that we can say goodbye to this bond-buying program, then private financiers can jump back into the European sovereign bond market with greater confidence and buy bonds from Italy, Portugal and Spain," Burkert told DW.
In fact, all three countries are on a stable growth path. Greece also appears to have put its deep recession behind it, and is looking forward to the first real increase in economic output in almost ten years. One might say that the ultra-loose monetary policy of the ECB finally has had its desired effect. One of the two main objectives of the bond purchase program has thus been achieved.
Although the rate of inflation, at 1.5 percent, is still below the ECB's target of just under two per cent, "we are not so far away that 1.5 per cent would be enough to justify keeping our foot on the accelerator" and continuing to buy sovereign bonds at the current pace, said Jens Kramer from Nord LB.
Recently, the strengthening of the euro vis-à-vis the dollar has caused some headaches amongst European central bankers. They fear that this could slow the exports of eurozone countries and destroy the tender shoots of economic growth. A tightening of monetary policy resulting in a rise in the eurozone interest rate would further strengthen the euro against the dollar. This, some argue, mitigates against reducing the scale of the ECB's bond purchases.
Uwe Burkert does not accept this argument. First, the current level of the euro compared to the dollar is not alarming. Secondly, the US dollar may soon strengthen: "If they manage a tax reform, which I think the Trump administration is likely to achieve, then we will have another euro-dollar relationship."
This means that ECB chief Mario Draghi must pull the reins of the monetary policy a bit tighter, whilst ensuring that the euro doesn't go through the ceiling. To achieve this balance, Draghi merely needs to keep all his options open, Burkert said: "He will say that he will, of course, be ready to extend and increase the loan purchase program at any time, as needed."
Read more: ECB's Draghi admits to 'knowledge gaps' in the face of new realities
That would not be a purely rhetorical proposition. According to the Commerzbank study authored by Jörg Krämer, the most important problem in the Eurozone - the general over-indebtedness of states, companies and private households - is not only not solved, but has actually increased in recent years.
This means the Eurozone crisis could return at any time – and that although the ECB must now ease back on its QE bond-buying program, it must also remain ready to step it up again if necessary.