“The risk of a triple-dip recession have increased. The ECB has one last arrow and that is quantitative easing of €1 trillion," said the credit rating agency
By Ambrose Evans-Pritchard
5:55PM GMT 18 Nov 2014
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The European Central Bank’s plans for €1 trillion of monetary stimulus is fraught with risk and is likely to fail without full-blown bond purchases, Standard & Poor’s has warned.
The agency said the ECB’s blitz of ultra-cheap loans to banks (TLTROs) cannot generate more than €40bn of net stimulus once old loans are repaid, given regulatory curbs imposed on lenders.
Jean-Michel Six, the agency’s chief European economist, said ‘doves’ on the ECB’s governing council know that the loan plan is unworkable but are going through the motions in order to persuade German-led ‘hawks’ that all conventional measures have been exhausted, even if this means a debilitating delay.
“Risks of a triple-dip recession have increased,” said Mr Six. "The ECB has one last arrow and that is quantitative easing of €1 trillion, needed to restore the M3 money supply to trend growth."
The ECB has suggested - with caveats - that it will boost its balance sheet by €1 trillion, saying this will be spread between TLTRO loans and asset purchases. The lower the share of TLTRO loans in this total, the more it will be forced to expand QE in the teeth of opppostion from Germany.
“The ECB is moving into very dangerous territory,” said Mr Six. "Their own credibility is at risk as they take on more risk, but it is necessary."
The agency also said the Bank of England has greatly under-estimated the degree of slack in the British economy and risks killing the recovery by tightening too soon.
“We don’t see any tangible signs of a housing bubble, except in a few streets in London,” said Mr Six. "The UK is cooling off. It is nothing to be alarmed about, but we think a premature rate rise could put the recovery in jeopardy. There is a long way to go before deciding the horse is going too fast and needs to be reined in."
Key officials at the ECB continue to fight out their differences in public. Jens Weidmann, the head of the Bundesbank, said there was nothing automatic about further stimulus and underlined that the €1 trillion rise in the balance sheet was an expectation rather than a target.
He also warned that it would encourage governments to relax fiscal austerity, an argument that most economists find baffling and not within the policy jurisdiction of a central bank official.
“The purchase of government bonds - independently of legal limits - would set significant, additional false incentives,” he said.
By contrast, the ECB’s president Mario Draghi has been nudging further towards full QE, stating explicitly that government bonds might be added to the mix of assets to be purchased.
Chief economist Peter Praet insisted in categorical terms that the ECB is not bluffing or playing with words. “We say we are confident, we are going to get the volume and, if it is not sufficient, we are ready to take additional measures and broaden the base of purchases immediately”, he said. Markets will surely now hold him to this sweeping pledge.
Standard & Poor’s said the ECB will have to launch radical stimulus to head off a deep deflationary slump in the end, whatever they say in Germany. It said the pool of assets that can be purchased will have to be broadened, including a €2.2 trillion pool of bank bonds, and ultimately sovereign bonds. Nothing can be done until the European Court has ruled on a former case involving its back-stop plan for Italian and Spanish debt (OMT). “That has to be behind us,” said Mr Six.
It is unclear whether the OMT case will in fact clear the air. Euroceptic groups and professors in Germany are already planning to file a fresh case against QE at the German Constitutional Court if the purchases escalate, arguing that the scale entails large liabilities for the German taxpayer and circumvents the budgetary sovereignty of the Bundestag.
They argue that QE is fiscal policy by stealth, conducted outside democratic control. Some experts say such a case would give the Bundesbank the legal excuse it wants to step aside from any ECB bond purchases, effectively rendering the ECB action null and void.
Mr Six said QE is a necessary condition for recovery in Europe, but is not sufficient in itself. “The question is where does this bridge take us,” he said. "The eurozone can survive a couple more years of miserable growth but it can’t go on forever like this before people lose hope. There is political risk almost everywhere."
On Britain, the agency said the “output gap” used to measure how far the economy is falling short of its potential is still 4.5pc of GDP. This is much higher than the 1pc estimate used by the Bank of England to justify talk of early rate rises.
Mr Six said the UK capital stock has been less damaged than widely assumed by the economic crisis, while abundant immigration has created a pool of cheap labour that is holding down wages.
Economists are deeply split over the size of the output gap: a soft indicator that is very hard to measure, but has nevertheless acquired totemic status. The International Monetary Fund and the OECD club of rich states both have estimates close to 1pc, while the Office for Budget Responsibility is at 1.4pc.
Yet a number of private analysts agree with Standard & Poor’s. Andrew Goodwin from Oxford Economics said the gap is 4.4pc based on weak productivity trends and historic evidence that financial crises do not destroy much existing plant.
“There is still a lot of spare capacity in the UK economy. The fact that wage growth has stayed so low for so long is evidence of this. We don’t think there should be any rate rises until the end of the next year at the earliest, and we don’t think there will be any either,” he said.
Standard & Poor’s praised the Bank of England for doing a“very smart job” in its response to the financial crisis by allowing inflation to overshoot its target at crucial phases, effectively eroding the debt burden by boosting nominal GDP. “This has improved Britain’s debt ratios,” Mr Six said.
The contrast with much of the eurozone is striking. The ratio of public debt to GDP has been rising fast in the most heavily indebted EMU economies, overwhelming any gains from austerity cuts.
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