ECB Goes All In with QE

On 5 March 2015, European Central Bank President Mario Draghi announced a €1 trillion quantitative easing program, allocating €60 billion in monthly security purchases until September 2016.
On 5 March 2015, European Central Bank President Mario Draghi announced a €1 trillion quantitative easing program, allocating €60 billion in monthly security purchases until September 2016.

After deciding earlier this morning to keep the discount rate at a record low 0.05%, Mario Draghi, the President of the European Central Bank, announced a quantitative easing programs of sovereign treasury notes, mortgage-backed securities, and covered bonds. The QE program will begin on 9 March with €60 billion of asset purchases until September 2016, totaling €1 trillion ($1.1 trillion). The program will purchase bonds with a negative coupon as long as the rate is not below the ECB’s deposit rate, which is -0.2%, but will not buy more than a 25% share of a bond issue to prevent the ECB from having a blocking majority in case of debt restructuring.

While this sort of economic stimulus failed in the United States with the Federal Reserve’s $3.5 trillion program, the ECB believes that expanding the money supply to increase the Harmonised Index of Consumer Prices, the Eurozone’s inflation indicator, will spur economic growth to a “prosperous level”, which Draghi describes as 1.5% annual GDP growth.

Even though the new 1.5% growth projection for 2015 is abysmal at best, it isn’t certain that the European Union will even achieve that. China, the EU’s largest trading partner, has lowered its GDP growth forecast to 7% for 2015 amid fears of a real estate bubble burst. Additionally, the possibility of a “Grexit”, or Greek exit from the Eurozone, would send Europe into an economic spiral, undermining the viability of the Euro. As stated in previous articles, none of the major problems facing the EU, such as inefficient state-owned enterprises, high tax rates, excessive regulation, and insolvent pension systems, are being rectified by national governments or the EU at-large. As a result, it should not surprise many that the region has difficulty achieving 1.5% growth despite €60 billion a month of asset purchases.

Perhaps the most depressing part of the ECB meeting earlier today were the HICP projections. While the 2015 inflation forecast was lowered to 0% from 0.7% in the December 2014 report, the 2016 forecast was raised from 1.3% to 1.5%. Why did these trends so in opposite directions? Draghi and other members of the ECB’s Executive Board are hoping that “an increase in oil prices will raise inflation to a sustainable level”. The ECB is betting the entire QE program on the prediction that OPEC’s hesitance to cut production will collapse the US shale industry, which can avoid default and liquidation despite a negative cash flow due to extra liquidity in global markets due to QE.

This leaves the question: has the European Central Bank turned into a complete joke? In the same QE announcement, the central bank said that its intention is to be market-neutral, with the hope of creating as little “distortion” as possible. If the ECB would abide by their own claims, the state of the European economy would be nearing a “prosperous level”.

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