Mario Draghi has fulfilled his promise and put into action the words “whatever it takes” – which he declared at the height of the debt crisis in July 2012 – to save the euro. After the first ECB Governing Council meeting of the year, its president announced the implementation of the much-anticipated Quantitative Easing (QE), a statement that has not only fulfilled but exceeded the markets’ expectations.
The Italian banker has led the ECB into unknown territory with a massive sovereign bond-buying plan that will be added to the existing private sector asset purchase program, amounting to a total of €1.14 trillion. This sum will expand the ECB balance sheet to €3.3 trillion. The goal is to quell the threat of deflation, and to reactivate economic growth, which remains stagnant in the euro area.
€60 billion a month
European QE will entail the purchase of €60 billion a month starting March this year until, at least, September 2016. The program is more ambitious than expected. The ECB will buy sovereign bonds in proportion to each euro-area economy, and with maturities from two to 30 years. This program will encompass the Asset-Backed Securities purchase program (ABSPP) and the covered bonds purchase program (CBPP3).
But what investors have liked the most is that Draghi has left the door open to continue with these purchases beyond September in order to fulfill his mandate of price stability. “They are intended to be carried out until end- September 2016 and will in any case be conducted until we see a sustained adjustment in the path of inflation which is consistent with our aim of achieving inflation rates below, but close to, 2% over the medium term.” The consumer price index saw its first year-on-year fall last December, driven by the downward pressure of sinking oil prices.
Risk sharing
Draghi has maintained that the Governing Council has been unanimous when considering this new way to print money as a monetary policy tool that is in line with EU law. However, there has been only ‘consensus’ on risk sharing. Even so, Draghi has managed to overcome the bitter opposition from German politicians and the Bundesbank by establishing loss sharing in case of a hypothetical state default.
Therefore, the 19 national central banks will be responsible for 80%, and the other 20% will be shared between the ECB and each member state. “There was a large majority on the need to trigger it now, and so large that we didn’t need to take a vote,” Draghi said at a press conference that followed the Frankfurt meeting.
With such a powerful new buyer in the market, bond prices will go up and their returns will go down, thus financial entities will, in theory, turn to more attractive sectors, and will consequently start lending money to businesses and households again.
To avoid any distortions within the market, the ECB has set itself some red lines. “We will buy government debt up to the percentage that will allow a proper market price formation,” Draghi explained without ruling out the possibility to buy bonds with negative yields. These red lines are the issuer limit of 33% and the issue limit of 25%.
Greece on hold
This limit implies that the ECB will postpone the purchase of Greek bonds because the country’s government debt portfolio is well above this limit as a result of past interventions. In Draghi’s words, purchases of Greek bonds will not be possible until July, which gives the ECB time to see to what extent the future Greek government coming out of the 25 January elections will be willing to commit.
The ECB president has insisted that the monetary policy alone will not fix the situation, and that is why “it is essential that Eurozone countries implement credible, fast and effective structural reforms”.
Another decision adopted by the ECB involves the targeted longer-term refinancing operations (TLTROs). From now on, the interest rate applicable to future TLTRO operations will be equal to the rate on the Eurosystem’s main refinancing operations which is now at a record low 0.05%, instead of 0.15%. Besides that, the ECB has also left the deposit facility – the interest charged on banks for depositing their money in the ECB – unchanged at -0.2%.
The euro’s reaction to QE was straightforward. The single European currency depreciated relative to the US dollar to its lowest level in 11 years and went under the 1.14 dollar threshold. Stock exchanges have celebrated it with gains whereas the returns of sovereign bonds in the public debt market have fallen to record lows in many cases.
The question now is whether this will work or has it come too late. What we know is that Quantitative Easing arrived in Europe six years after being positively implemented in the United States, where the Federal Reserve is now getting ready to raise interest rates. This sum will expand the ECB balance sheet to €3.3 trillion. The goal is to quell the threat of deflation, and to reactivate economic growth, which remains stagnant in the euro area.
