ECB MAY HAVE TIDE ON ITS SIDE / THE WALL STREET JOURNAL

Heard on the Street

ECB May Have Tide on Its Side

The ECB May Be Starting QE Just as the Economy Fares a Little Better

By Richard Barley

Jan. 22, 2015 12:23 p.m. ET

      The new ECB headquarters in Frankfurt. Photo: Reuters        

For Mario Draghi and the European Central Bank, it may be better to be lucky than good.

The ECB on Thursday crossed the Rubicon, announcing a €60-billion-a-month ($68 billion) program of bond purchases, including eurozone government bonds. The program will run from March until at least September 2016—implying total purchases of more than €1 trillion—helping to lift the ECB’s balance sheet back toward €3 trillion.

Importantly, Mr. Draghi said purchases would continue until the ECB sees a “sustained adjustment” in inflation—currently minus 0.2%—that is consistent with achieving the central bank’s target of below, but close to 2%. That is the open-ended commitment the market wanted to see. After some initial volatility, markets signalled approval: stocks rose, the euro fell against the dollar and southern European government bonds rallied sharply.

There is plenty for investors and markets to digest. The new quantitative-easing program incorporates existing purchases of covered bonds and asset-backed securities. These programs have been running at about €13 billion a month, HSBC notes. In addition, the ECB will buy bonds of European institutions; so purchases of government bonds may be somewhat less than €50 billion a month. But the ECB said it would buy bonds with maturities of up to 30 years, a positive surprise, leading to a big rally in long-dated debt.

Then there is the vexed question of risk sharing—whether the ECB would be able to take all the risk on its balance sheet of bond purchases. Despite the ECB declaring that these purchases represent a pure monetary-policy operation, a compromise solution was necessary: 80% of the risk of the additional purchases announced Thursday will reside with national central banks. For now, the size and scale of the program will probably trump market concerns, but this could still lead to problems down the road.
And then there is the eternal question: what will this do for the eurozone economy? QE is aimed at raising the path of inflation. But Mr. Draghi, in addressing a question on fears of hyper-inflation, himself pointed out that since the QE era started, high inflation hasn’t been the problem.

With the eurozone depending much more on banks to grease the wheels of commerce, it isn’t clear that a capital-markets intensive solution is the right one. And Mr. Draghi, perhaps wearily, reminded eurozone governments that without them, monetary policy can’t do everything. Critics of the ECB will now be watching for signs that governments decide they can dodge hard political questions about reforming their economies, hoping instead to let the ECB do the heavy lifting.

All that said, it might just be that Mr. Draghi’s timing is, once again, impeccable. His intervention in July 2012 with a pledge to do “whatever it takes” to save the euro came at a critical juncture. And now, the start of the ECB’s QE program may arrive just as the eurozone economy starts to lift its head a little.

Although lower oil prices have put downward pressure on inflation, they should also give a boost to eurozone consumers and companies. So, too, should the decline in the euro. And bond yields are already at extraordinarily low levels. Meanwhile, the ECB’s bank-lending survey has been painting an improving picture, with banks more willing to lend and companies showing an appetite to borrow, including for investment. In Germany, some indicators such as the ZEW and IFO surveys have turned upwards, suggesting better times ahead.

In fact, some of the aura around QE may have come about because in the U.S. the start of bond purchases largely coincided with a turn upward in economic data, Goldman Sachs notes. Given that confidence is an important component of QE’s power, a similar development could prove crucial for the ECB.