There are many more questions than answers when it comes to the European Central Bank. Expectations that the bank may start printing money have strengthened considerably following a run of weak European data -- especially weak inflation data that has intensified concerns over deflation.
What we don’t know is how large the program would be, what assets it would target and how long any program might last. Suffice to say that if the market is underwhelmed by what is regarded as an overly cautious central bank, equities may not get much of a lift at all. Conversely, any positive surprise would likely be met with a solid rally. Assuming the latter, how long would the euphoria last? Unlike when the Fed ratcheted up the printing presses, there is no reason to believe that any ECB QE-induced rally could be sustained for long.
For a start, and in the American context, QE came at a time of already accelerating growth. Additional money printing was just the cherry on top. Moreover, the US economy was never close to deflation at any time. So while it may not have seemed like it, there was very little to actually worry about on the US economy. Fictional dramas were about it -- and of course what to do with all that free money.
In Europe’s case, things are different. Growth is tragically low and inflation is already into negatives. Against that backdrop, the question is (or at least should be), what additional benefit could the ECB’s QE program possibly bring?
It’s not like QE is the first money printing program that the European Central Bank has undertaken. Under the Bank’s main refinancing operations and the so-called long term refinancing operations, the ECB’s balance sheet actually peaked in 2012 at about €3 trillion.
The ECB’s balance sheet is already demand-driven, with banks able to borrow unlimited amounts of money -- all they wanted (assuming they have the collateral) at ultra-low rates. Admittedly this wasn’t strictly money printing as these loans have to be repaid with interest.
Since that peak, the bank’s balance sheet has declined by around €800bn to around €2.2 trillion. The best case scenario is that the ECB’s balance sheet swells back to €3 trillion indefinitely. But then, so what? QE is just one more in a series of programs to provide liquidity to the European economy.
But liquidity clearly isn’t the problem in Europe. The problem is that these past operations have done little to lift either growth or inflation on a sustained basis. Credit growth has remained anaemic and QE cannot possibly be any different. QE cannot force businesses and households to borrow.
Then we have to consider that European bond yields are already exceptionally low -- at record lows. The German 10-year bond is at 0.47 per cent, the 5-year rate is around 0, even falling into negative rates at times. That is, investors pay the German government for the privilege of lending them money! It’s not that much different elsewhere – Italy’s 10-year rate is 1.8 per cent and Spain's is 1.6 per cent, in each case lower than the US 10-year at 1.9 per cent (Australia’s is at 2.6 per cent). So it could hardly be said that QE is required for lower longer-term rates. They are already at record lows and seemingly having no impact on the economy.
With that in mind, it’s entirely plausible that QE could have the opposite effect to that intended. There is nothing more concerning to markets than failure. And it’s quite clear that the ECB’s QE program will fail.
Take a look at the Nikkei. It has had a sugar rally over the last few months or so, but the structural bear market remains. There is nothing that sustains Japanese equities other than BoJ money printing. This is not an enviable situation, and not something to which the Europeans should aspire.
A weaker euro would be positive of course, but for how much longer can euro keep falling? The ECB’s money printing program is priced-in. Elsewhere, it may simply tempt to the Fed to hold off for longer -- certainly that’s the rhetoric -- and the Bank of Japan needs no new excuses to print ever more money.
Bigger picture, it’s clear that markets are becoming increasingly distrustful of central banks. I’ve argued for some years that central banks have been the great deceivers, speaking with forked tongues. This idea has gained considerable traction, especially following the SNB’s recent decision. This uncertainty that policymakers have introduced is spooking markets. And, while we are not quite there yet, it may soon get to the point where the less done, the better.