We recently received a question from one of Alvexo’s followers on Twitter, asking us how effective is ECB’s Asset Purchasing Program.
To answer that, let us take a look back. Mario Draghi, the president of the European Central Bank, has been facing headwinds in his attempts to jumpstart the economy of the European Union since the beginning of the year in the form of uncooperative regional governments that refuse to adopt policy and fiscal stimulus measures. Cutting interest rates to 0.05% in September 2014 has resulted in a low-trending Euro, thanks also to expectations of a rate hike, compliments of the US Federal Reserve. That, plus increased growth in Spain and France have provided Draghi with the required encouragement; however, there remain impediments to regional growth that compel more drastic monetary measures. Although it is too early to judge the long-term effectiveness of shifting policies, the near-term accomplishments are showing mixed results.
The first challenge to restoring growth the Eurozone has proven to be holders of regional sovereign debt. It has now been three months since the ECB launched its own unique form of quantitative easing, and some factors can now be evaluated. The ECB’s mandate dictates a 2% inflation target to maintain maximum price stability without risking deflation. To achieve this level, the bank has prescribed a EUR 60 billion monthly purchase program of assets, starting in March 2015 and due to end in September 2016. To date, the sum of purchases is EUR 160 billion – 20 billion below target. The reason for the margin is the diminishing availability of bonds, primarily owing to the unwillingness of pensions and other large non-retail investors to sell sovereign debt.
Another hindrance has been austerity and convoluted rulings, which have prevented the ECB from executing the main bulk of its purchases earlier, rather than during the summer months, during which vacations reduce the availability of buyable assets. Moreover, the Maastricht Treaty itself imposes debt-to-GDP ratios that limit purchase goals, quite simply because governments are hesitant in taking loans – even with borrowing rates at record lows and falling. As a result, projects show that for the entire year, little over EUR 220 billion in bonds will be issued in 2015 – nowhere near the ECB’s EUR 600 billion goal. Add to that that the ECB may not buy bonds under a -0.2% deposit rate, and that a large proportion of the zone’s EUR 1.2 trillion in liabilities is trading at negative yields, and one realizes that the supply will continue to diminish in line with falling yields.
Euro Area Annualized CPI
Without doubt, inflation and employment levels have been improving quite dramatically throughout the continent since the beginning of the QE program. Even lending has risen. But should these factors be attributed to Quantitative Easing? Inflation, for example, had begun to improve well before Draghi’s program was set in motion, thanks to a Euro weakening due to external circumstances. In fact, increased employment, spending and trade may have been driven by the competitiveness of European exports and low prices. And since inflation is still far from the coveted 2% level, and short-term jumps may simply be momentary noise.
Euro Zone Unemployment
Employment, inflation, lending and growth should be judged over a longer term in order to truly assess the success of Draghi’s deeds. Unfortunately, low-to-negative interest rates have rarely encouraged investment.
Preliminary signs are indeed positive, and if inflation and lending continue to improve, the region may experience real growth. The alternative is banks funneling cash towards equities rather than encouraging low-rate loans, thereby quashing the potential benefits of loose monetary policies.
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