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€1.1 trillion gamble to save the eurozone

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The headquarters of the European Central Bank (ECB)

The headquarters of the European Central Bank (ECB)

Bloomberg

Finance Minister Michael Noonan

Finance Minister Michael Noonan

Mario Draghi, president of the European Central Bank (ECB). Photographer: Martin Leissl/Bloomberg

Mario Draghi, president of the European Central Bank (ECB). Photographer: Martin Leissl/Bloomberg

Bloomberg

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The headquarters of the European Central Bank (ECB)

A tsunami of money is set to flood Europe over the next two years if the European Central Bank meets expectations today by announcing a stimulus programme worth as much as €1.1 trillion.

ECB policymakers have proposed injecting €50bn every month into the ailing Eurozone economy, starting after March 1.

Reports said yesterday that the stimulus programme could be launched in March and continue to the end of 2016. The details were discussed last night by ECB president Mario Draghi and other governors from around the Eurozone. Further discussions are due today before an announcement at lunch time. Ireland's Patrick Honohan will be speaking at the meeting but cannot vote on the crucial measure under new rules to streamline the decision-making process.

European stock markets have been hovering at record highs in recent days on hopes that the sea of money heading into Europe's companies and citizens will boost sales and exports. The Euro has meanwhile sunk to an 11-year low amid concern that the complex bond-buying programme, which is usually termed quantitative easing but is little more than money printing, devalues the currency.

The decision is widely seen as one of most important in the ECB's short history.

Doubt

While a bond-buying programme is almost certain, it was far from clear last night whether the ECB will plough ahead with a German-backed scheme to ask the 19 Eurozone central banks to shoulder the risk for purchases of their government bonds.

The idea is vehemently opposed by Irish Finance Minister Michael Noonan, who said this week it could make the system unworkable.

Mr Noonan argued that having national central banks buy individual nations' bonds and shoulder any losses on those bonds undermines the idea of risk sharing which has been part of recent responses to the Eurozone crisis.

Such a plan is, however, supported by powerful countries such as Germany and the Netherlands. The decision is expected to go down to the wire in debate today.

An Italian finance ministry official said yesterday that there was "concern" in Rome about national central banks taking on responsibility for their own bond purchases. "If QE is done through fragmentation, it will not be effective and it will not be coherent with a truly unified Europe," the Italian official said, adding that the size of the programme was less important than its structure.

The ECB is expected to buy all sovereign debt with an investment grade rating of triple B or higher, such as Ireland.

Nations with junk ratings would only qualify if they were part of a reform programme. Conditions are likely to be set in a way where Greece would be unable to participate in bond buying immediately.

 

Q & A

Q: What’s the big deal?

A: The European economy is flagging. Economic growth is sluggish and the Eurozone went into deflation – a general fall in the level of prices – in December. That’s not good. Falling prices encourage people to hold on to their money in the hope that they’ll gain by putting off purchases as things keep getting cheaper.

That means less demand for goods and services, which would hit economic growth. So even though interest rates are already through the floor, the ECB wants to use another trick to help give the economy a boost.

 

Q: What kind of trick?

A: Something called quantitative easing (QE). In essence this involves the ECB printing money in order to buy bonds. The idea is that QE will inject more cash into the economy and encourage banks to lend more money.

Then, as people spend more, the increased demand for goods and services will lead prices to rise.

 

Q: What is a bond?

A: Essentially a form of loan. A company or government that sells a bond is being loaned money by the person who buys it. The seller agrees to repay the buyer a fixed premium (or yield) on top of the headline cost over a certain period of time.

But that’s not the end of the story. The person who buys the bond can then sell it on to someone else – the ECB for example – in exchange for the right to be repaid.

 

Q: Will this programme work?

A: It’s too early to say. Observers are divided, to put it mildly.

Much will depend on the size of the package that the ECB brings forward. Indications last night were that it could be worth as much as €1.1 trillion, spread out over the next two years.

That would be higher than most observers were expecting a week ago, and would be received well by the markets, according to Cantor Fitzgerald Ireland’s head of fixed income strategy Ryan McGrath.

In theory, the more money the ECB pumps in to the economy, the bigger the stimulus will be.

 

Q: Surely this has been tried somewhere before?

A:  Of course. The most high-profile recent example is in the US, where the Government injected about $1.7 trillion into the system by buying up lots of bonds between 2008 and 2014.

Most observers see the US’s QE programme as a qualified success. While the economy is headed back towards full employment, US inflation remains low.

 

Q: What are the potential risks?

A: One risk is that investors will be tempted to switch away from Government bonds and towards riskier investments.

Why? Because with the ECB buying up massive amounts of bonds, basic economics dictates that the price of bonds will rise.

The yield is based on the initial cost of the bond, so if the price of the bond gets higher that means the rate of return is lower in percentage terms.

So if investors take too much risk and the economy stays in the doldrums – a lot of people could get badly hit.

If you ask a German policymaker they’ll probably tell you that quantitative easing discourages governments from getting to grips with budget problems – a so-called “moral hazard”.

Chancellor Angela Merkel appears pretty wary.

“All signals have to be avoided that could be perceived as weakening the necessity for structural changes and closer economic-political cooperation in Eurozone countries,” Ms Merkel said yesterday.

Our own Finance Minister Michael Noonan raised another potential problem earlier this week.

Though it’s not clear how the stimulus programme will look at the time of writing, it’s been widely reported that the ECB might ask national Central Banks to take responsibility for buying their own bonds – possibly at a loss.

That approach would undermine the idea of European countries sharing risks for policies meant to benefit the whole of Europe, Mr Noonan argued.

Given our own recent history with bondholders, taking the hit for Europe again would be tough for Irish people to stomach.

 

Q: What might the impact be on Ireland?

A: If there’s a general increase in demand across Europe that will be good for our exporters.

The value of the euro is likely to keep falling as more euros are pumped into the economy, and that will help exporters too as their products will be cheaper to buy in countries outside the Eurozone – like two of our major trading partners, the US and the UK.

And if bond yields continue to fall, that should mean that Ireland’s borrowing costs, already at record lows, continue to drop.

Irish Independent