In July 2012 when ECB president Mario Draghi gave his ‘anything it takes to save the euro’ speech, some commentators believed that he was bluffing.
The proposed Open Market Transactions (OMTs), which were designed to purchase the government bonds of countries such as Spain and Portugal in order to lower interest rates, in return for structural reforms, have never in fact had to be used. The threat has been enough to bring down rates, such that 10 year Spanish Government bonds are now yielding 2.65%, marginally below UK rates. In July 2012 Spanish rates were 6.65%.
Will the same be true of Draghi’s latest press conference last week where he appeared to be moving towards fully fledged QE in order to transmit monetary easing to the real economy?
It seems to me that Draghi has in the past faced some difficulties in his press conferences; he is an Italian in a German city speaking English to an audience (or at least markets) which often seem to be dominated by Americans. This can lead to misunderstanding!
This is not to suggest that his spoken English is anything less than the smoothly honed tone of an investment banker; but the subtleties of language required to keep happy the interests stretching from the austere Germans to the perceived profligacy of the Latins can be hard to interpret, particularly, dare I say it, by our American cousins, who are used to a more straightforward approach.
But in last Thursday’s conference Draghi was pretty crystal clear; the Council was unanimous (in 2012 the Germans had voted against OMTs) in its decisions to lower interest rates, adopt a sort of funding for lending scheme a la Bank of England and investigate the possibility of QE.
Will We Get Quantitative Easing?
Furthermore, in answer to a question, Draghi said: ‘We think it’s a significant package. Are we finished? The answer is no, we aren’t finished here. If need be, within our mandate, we aren’t finished here.’ In other words, QE is coming if inflation remains too subdued for the ECB’s comfort under its mandate which is stated to be to achieve inflation of below but close to 2%; the latest inflation rate for the Eurozone was 0.5%.
Markets had been pricing in the lowering of the base rate from 0.25% to 0.15% and the negative interest rate on deposits held at the ECB; the funding for lending and hints of serious QE were probably mildly positive surprises.
Is the Euro-zone crisis over?
Almost certainly not, for one thing we are shortly going to have to navigate the treacherous process of the major European banks being assessed for capital adequacy by the ECB, which could throw up some shocks. But more importantly whilst the ECB can lead the horse to water, it can’t make it drink; the demand side of the equation, ie investment by businesses and spending by consumers has to cut in at some point, or the Euro-zone will remain becalmed in a Japanese style deflation.
Monetary policy can be, as Keynes once observed, like ‘pushing on a piece of string’.
Nonetheless, it may be a necessary, but not sufficient, condition for economic recovery that all the monetary levers are pulled and we are getting towards that point. This of itself should engender some confidence and, with the risk of a Euro collapse having been lessened in 2012 and the ECB now finally beginning to act as if it were a proper Central Bank faced by deflationary forces, it is just possible that we are through the worst.
And a good bit of European QE might go down well at the time that both the Fed and the BOE are heading in the opposite direction.