ECB: It's QE Jim, but not as we know it

The ECB didn’t disappoint the market – it announced a QE programme that beat market expectations. The ECB played a canny game – on Wednesday sources said that the ECB would discuss a EUR 50 bn a month programme of asset purchases, so the announcement that the ECB would embark on EUR 60 bn of purchases per month was an easy way to “beat” expectations. But don’t be fooled, the ECB’s programme is nothing like what we have seen from the Fed, BOE or BOJ.

Here are the details:

• EUR 60 bn per month of asset purchases.

• Purchases will run from March 2015 – September 2016, but may be open ended.

• It’s tied to price stability.

• The total size of the programme is EUR 1.08 trillion.

• It will buy both public and private sector assets.

• Only 20% of the programme will be have risk-sharing, where all members of the Eurozone will share losses, while national central banks will have to take responsibility for any losses on 80% of the purchases.

• The ECB also cut the interest rate to TLTRO loans, to try and boost their take-up.

• ECB will buy debt with maturity of 2-30 years.

• All members are eligible; however countries that receive bailouts (i.e., Greece) will be subject to special rules.

• Purchases will be according to the ECB’s capital key, in other words they will correspond to their share of Eurozone GDP – so the majority of assets purchased could be German.

Eurozone: only 20% united and still not bailout-proof

The initial reaction to this announcement is that the ECB has embarked on full-scale QE, but this is wrong. Full blown QE is when a central bank buys assets from banks, assuming any potential losses with the knowledge that if losses mount then they can always print more money to get themselves out of any trouble. Without full-blown risk-sharing then assets, and risks, sit on member states’ central bank balance sheets, which don’t have the power to print money. So, if these assets loose value, then the national central bank may still have to rely on a sovereign bailout. Thus, this form of QE is not bailout-proof.

This is probably the work of the Bundesbank, who don’t want the German taxpayer on the hook for bad loans from its neighbours. This highlights the political risks of QE in the Eurozone, today’s decision actually drives the currency bloc apart, not closer together. To borrow from the FT’s Martin Woolf, he said that the Eurozone is more at risk from German “pathological frugality” rather than profligacy from other nations.

Draghi said that the decision was unanimous, however it is unlikely that the Bundesbank would have voted on the programme if it didn’t include the caveat around risk sharing. This makes the minutes of this meeting, which will be published for the first time, extremely interesting. This decision was obviously a huge compromise, so who gave ground, and did they give ground willingly?

A EUR 200 bn programme?

In comparison to Fed or BOJ-style QE, the ECB’s QE programme is actually only EUR 200 bn over 18 months, as this is the only portion of the purchases where risks will be shared among member states.

One area where the ECB follows the Fed/ BOJ style is that although purchases are only expected until Sept 2016, the bank could expand this programme if the Eurozone’s inflation rate has still not stabilised.

Opec could do more to boost the Eurozone…

We think that this programme is very good news for Germany, hence the sharp decline in German bond yields. The ECB must now hope that the German economy can pull the currency bloc out of deflation.

Although the oil price has been rising today, it has fallen back from recent highs in the aftermath of Draghi’s statement, and the remains below $50 per barrel. Considering the ECB has tied its QE programme’s success to an increase in the inflation rate, a bigger boost to the Eurozone economy could come from Opec, if they cut production forcing a supply reduction, which may lead to an increase in the oil price.

Conclusions:

• The market reaction has been a lower EUR, lower oil but higher stocks. This suggests to us that the market believes that the ECB will have to do more to reach its desired outcome of higher prices.

• The ECB has left room to take further action – if they could persuade the Germans to share risk then this QE programme could be more potent, they could also boost purchases of assets from member states with struggling economies.

• EURUSD: if we get a daily close below 1.1460, then the market focus may be on 1.10.

• Yield spreads: yield spreads continue to narrow, with peripheral bond yields falling at a quicker pace than German yields – this should please the ECB.

• Overall, we think that the risk sharing issue is the biggest problem with this QE programme, which could make it less effective. However, the ECB has pegged this programme’s success to price stability, thus it needs to keep on pumping the economy with money until prices start to rise, which is being seen as a radical move by the G10’s most conservative central bank.