More money, more problems? Draghi's QE quandary

ECB President Mario Draghi is confident about what the central bank's QE program will achieve, but a number of risks pose a threat to his plan.

It’s the most precisely anticipated QE program announcement in history. With a total spend in line with expectations for €1.1 trillion of government and corporate bond purchases, and partial shared risk between member countries, the ECB’s plan landed just on broad market expectations in the City.

But amid the careful execution and delivery of the bank’s final announcement -- following weeks of blatant hints -- several comments scratched a sharp line under its struggles to control the vastly more important expectations on growth.

The markets’ initial reaction was comfortingly positive and proportionate. The euro plunged -- a sunny omen for price inflation that has eluded the currency’s significant weakening to date. 

Spanish and Italian bond yields hit record lows, while German bunds (a relative safe-haven among their neighbours) rose. Stocks on both sides of the Atlantic brightened.

European stocks, having priced in anticipation of some degree of disappointment in the detail, despite recent rises -- particularly following ECB governing council member Ewald Nowotny’s exhortation to "not get too excited" --  were focused on the upside and closed higher. The FTSEurofirst rose by 1.6 per cent to seven-year highs, while the German Dax climbed 1.3 per cent and the UK FTSE lifted by 1.0 per cent.  

In Europe, however, where the medium for delivering a monetary policy shift is still so formative to its success, the risks apparent in Draghi’s message remain a tangible threat to his plan.

One threat follows in the wake of two German newspaper interviews, in which the bank recently tried to pour oil on strong German displeasure with QE. Spelling out “technical preparations” to alter the “size and composition of programs early in 2015”, it specifically prepared markets for QE during the prior fortnight after months of building speculation.

That same German antipathy was not vanquished in Draghi’s announcement of a small, 20 per cent component of risk-sharing among new government bond purchases, in which national government purchases will be weighted according to each country’s size.

Following Berlin’s staunch opposition to eurozone QE, this was a welcome win for ECB freedom to pursue a larger agenda. But there was a view among analysts that the failure of greater unity would let doubts fester over the union’s political future, keeping a chain around confidence.

Likewise, Draghi’s message that a vote count on the program was not needed due to the ‘majority’ of council members for immediate QE action sidestepped the need to reveal any damaging breakdown of ballots cast. But a shadow was cast by the absence of verbal support from Berlin.

Berlin’s opposition to risk-sharing is about more than this weekend’s Greek elections. With a rating of ‘junk’ status, it seems Greek bonds will be left out of the ECB’s 'investor-grade’ purchases. But the decision to delegate a proportion of purchases nationally telegraphs a warning to Spain, France and others with strong anti-euro parties.

Meanwhile, Draghi’s lonely plea for more helpful settings, amid the limits of what monetary policy can do, spotlighted regulatory settings looming over the bank’s QE success.

“In particular, the determined implementation of product and labour market reforms as well as actions to improve the business environment for firms needs to gain momentum in several countries,” he said.

“It is crucial that structural reforms be implemented swiftly, credibly and effectively as this will not only increase the future sustainable growth of the euro area, but will also raise expectations of higher incomes and encourage firms to increase investment today and bring forward the economic recovery.”

As the IMF swiftly added its oft-repeated appeal for “comprehensive and timely” growth-boosting structural reforms, there was some hope in the City that the ECB’s large step closer to its the limits of its capacity might bring that message greater heed. As the bank noted earlier this week, it has not many more  options left.

Also among troubling external settings are the current state of Europe’s bank balance sheets. With far higher debts than US or Japanese banks when their respective governments began QE, there is risk that lower borrowing costs may be used to shore up their own books, slowing the trickle of lending through to the real economy.

In a partial nod to this, continuation of the ECB’s current corporate asset purchasing program, which began in September, goes some way to pushing for a shift in lending markets.  Currently hampering recovery, a far lower proportion of lending to Europe’s corporates comes from financial markets than banks, compared to the US. (Separately, the city of London has identified this lending trend as one of its own biggest threats to growth.)

Amid the sound of these threats breathing down Draghi’s neck, one markedly upbeat note was his own implied benchmark for the program’s success. QE would continue from March until at least September 2016, he said, or until a “sustained” improvement in inflation “consistent with [the] aim of achieving inflation rates below, but close to, 2 per cent over the medium term”. But he expected the bank's interest rates, with support from the new measures, to increase “gradually” later in 2015 and 2016.

In the meantime, consumer price inflation, which turned negative in December, was set to remain “very low or negative” in the months ahead.

Staring at a larger deflationary trap, Draghi’s words of confidence in the program’s success are much needed. Whether they can believed is another matter.

And what becomes of Europe’s QE program now is largely up to others.

Amber Plum is Business Spectator's London editor. Follow her on Twitter @amber_plum