Monday 26 August 2019

Slowly weaning Eurozone off financial steroids may mean bad comedown later

ECB boss Mario Draghi announced last week that stimulus would be
halved to €30bn a month but for an extended period until September 2018. Photo: Bloomberg
ECB boss Mario Draghi announced last week that stimulus would be halved to €30bn a month but for an extended period until September 2018. Photo: Bloomberg
Richard Curran

Richard Curran

The European Central Bank decided last week to extend its multibillion euro bond buying programme for another nine months. The quantitative easing programme (QE) sees the ECB buy up around €60bn worth of government, corporate and various asset-backed bonds in the market every month.

ECB head Mario Draghi is widely seen as having played things well last week but announcing a reduction in the amount of monthly QE from €60bn to €30bn while managing expectations and avoiding any shock or panic that this enormous financial steroid might be withdrawn in a hurry.

QE is loosely described as 'printing money', which immediately has the connotations of hyperinflation and people having to take their weekly wages home in a wheelbarrow, because their money's buying power is diminished.

While QE does involve creating new money to buy these bonds, it isn't necessarily distributed throughout the whole economy, through higher wages for example, and so far it has avoided creating significant inflation.

But it doesn't mean that it has not created an artificiality that could become very real when QE is finally removed.

There have been several benefits to Ireland from the ECB's QE programme which began in 2015. The ECB has bought up around 40pc of our national debt. In doing so, it has outbid other buyers of the debt, which has made it cheaper for the State to raise money.

The annual interest bill on our €200bn national debt is due to fall from €9bn in 2014 to under €6bn by 2020. That involves paying out €250m a week less in servicing our national debt.

The ECB programme has also shifted into buying up corporate bonds. This has also reduced the cost of debt for big international companies such as Unilever, Repsol, Shell and Nestle.

Among Irish companies, it has bought Ryanair, Kerry and CRH bonds which have helped those companies to refinance debt or borrow to acquire new companies at lower rates.

The QE programme has also seen tens of billions spent buying up asset-backed securities which are like traded bonds backed up by pools of mortgage or credit card debt.

Accompanying the massive asset-buying spree are record low interest rates. The ECB signalled last week that it would not only continue the QE programme until September 2018 or longer if required but that it would not put up interest rates until well after the bond buying stopped. This means we are highly unlikely to see an interest rate rise until 2019, possibly at the earliest.

This also spells good news for mortgage holders or anyone else carrying debts that have to be serviced. The Irish economic recovery has been fuelled by a number of benign external factors that are outside our government's control.

These include low oil prices, low interest rates and a relatively cheap euro. The euro has risen sharply against sterling, following the Brexit referendum but for now at least, is hovering around the 88p mark instead of kicking on for parity.

Oil prices have gained but there is little sign of a significant and sustained oil price spike on the horizon unless US president Donald Trump gets very trigger-happy with his military arsenal.

Fears of interest rises prompted some mortgage holders to plump for fixed-term mortgage rates for a few years. Bank of Ireland in particular was pushing fixed rates as it refused to drop its standard variable rates in line with competitors like AIB in recent years. Those who opted to fix in the last two years may have bought some peace of mind but it has come at a price, as rates are not likely to go up until at least 2019.

Nevertheless, put all of these aspects of last week's ECB announcement together, and it does appear to be good news for Ireland. But is it?

The reason ECB chief Mario Draghi is keen to keep QE going is because he doesn't believe Eurozone economies in general are ready to do without the financial support it brings. Some of the bigger ones are struggling to keep their budget deficits within Eurozone rules. Countries like Italy have structural economic challenges. Eurozone growth is picking up now but it remains fragile.

Fragility is not a word one might associate with political economic rhetoric in Ireland. Our economy continues to outperform the rest of Europe in headline growth terms and it could be argued that it doesn't need any more artificial stimulus.

Does CRH need an artificially created lower borrowing rate to help it fund acquisitions in the US, Indonesia or wherever? Does Ryanair need to have its borrowing cost lowered by ECB money when it says that a massive pilot resourcing issue won't dent this year's profits?

How realistic is it to think that the Irish state can continue to borrow 10-year money at an interest rate or coupon of just 0.6pc?

The potential problem for Ireland is always the same when it comes to the ECB. As a tiny percentage of Eurozone GDP, our economic needs at a particular time might not be best served by ECB decisions.

The same may well apply as QE is wound down. Timing and pacing will be everything. We could have a situation where in 2019, the QE programme comes to an end and our sovereign borrowing costs rise substantially. That year we could also see the UK crash out of the EU. It could also be the same year that interest rates start to go up for the first time in years.

This would have dramatic consequences for our housing market, our stock market and our exchequer funding position.

Thankfully, the NTMA has successfully pushed back debt refinancing well into the future. The maturity profile of our debt has been extended by 11 years, the longest among the EU28, where the profile is around seven years.

This would all help but equally our debt burden is substantial. Our general government debt is 275pc of general government revenue, compared to an EU28 average of 165pc. Interest payments, at these historically low and probably unsustainable levels, are still 8pc of all government revenue. That is twice the average for the EU28.

Draghi may have done us a favour last week, but perhaps only by postponing a bit of a reckoning rather than avoiding it altogether.

QE remains a controversial central bank tool. It began in the US in November 2008 and lasted until 2014. During that time it pushed up share prices, which benefited certain sections of American society in particular.

Critics say it has heightened social inequality. The idea is that if you don't have much by way of assets you cannot benefit from its targeted stimulus which bolsters the price of bonds, equities and other asset classes.

In the US, the Federal Reserve has said it will start selling down some of the $4.6trn in assets it acquired through its QE programmes. This could trigger a wobble in some asset classes, including the stock market, if it is not very carefully managed.

In Europe, the ECB is still well behind reaching that day. It will continue buying up assets at €60bn per month until January, and then at a rate of €30bn per month until September 2018 at the earliest.

It will also reinvest the money it receives in principle payments from the assets it has already acquired. It has bought up so much in Eurozone government bonds, it has been suggested that there isn't that much qualifying state debt left to buy.

This should lead to a shift toward more corporate bond purchases as the programme enters 2018.

Perhaps the best way of putting is, that last week's announcement reduces the chances of a short-term shock or crash, but increases the risks of something bad a little further out.

How are we preparing for this in Ireland? We are pushing the Government to cut taxes and spend more money, while we rediscover our appetite for borrowing - both personal and corporate.

Surely some mistake.

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