Thursday 21 November 2019

Why we are in good place to enjoy rising tide of QE

'The ugly QE phrase simply means that lenders to governments - mainly banks - will get back the money they are owed now, rather than on the due date'
'The ugly QE phrase simply means that lenders to governments - mainly banks - will get back the money they are owed now, rather than on the due date'
Brendan Keenan

Brendan Keenan

The responses to the euro crisis have always been criticised as too little, too late. The decision by the European Central Bank to create over one trillion of new money has come very late in the day, but it can hardly be called too little.

The purchase of €60bn worth of loans to Eurozone governments each month until at least September 2016, under so-called "quantitative easing", is right at the top of what analysts expected, after fierce rows with Germany and a couple of other countries over the programme.

The criticism now will not be that it is too little, but that it is the wrong approach. The ugly QE phrase simply means that lenders to governments - mainly banks - will get back the money they are owed now, rather than on the due date.

They will have more cash to play with and the hope is that they will play with it by lending it to businesses and households, thereby boosting economic growth.

To be precise, that is the general hope. The ECB dare not say that, because it has no mandate to encourage growth. Instead, president Mario Draghi insisted that the goal is to get inflation back up to the ECB target of just under 2pc. "This is purely a monetary policy tool," he said.

The fall in Eurozone prices last month gave Mr Draghi and his supporters on the ECB Governing Council the opportunity to launch the QE programme. The bank's mandate - insisted upon by Germany - is "price stability." Deflation, where prices fall, cannot be regarded as stability.

But pretty much everyone, including probably Mr Draghi, sees the restoration of normal growth in the Euro area, after five years close to recession, as the biggest benefit all this new money could bring.

But almost everyone also thinks QE is not the best way to go about it. They would prefer more borrowing by governments, which passes directly to firms and households in the form of lower taxes and higher government spending. Giving the extra cash to banks runs the risk that they will hang on to it, both to improve their own financial position and because they cannot find enough safe customers to lend it to.

Timing is everything, though. This week's statistics did show signs that banks are loosening their stance. And the QE programme itself may encourage them to be more expansionary.

They will need to release the cash because extra government borrowing, although adopted to some extent by the US and UK governments, is right off the table in the Euro area. Indeed, the fear in Germany, and other creditor countries such as Finland, is that QE will in fact allow deficit countries, such as Italy or Ireland, to borrow more.

Before we start Germany-bashing, it should be said that this is a reasonable fear.

If banks get ECB cash for their existing government loans, one obvious thing to do with the money is to lend it to governments again.

This would drive down interest rates which are already at historic lows. That is part of the intention but allowing governments to take advantage of it by borrowing more is not. To help guard against it, Germany insisted on a major departure from existing practice. Only one euro in five will come from the ECB in Frankfurt. The rest will be issued by national institutions such as the Central Bank of Ireland.

Should the Irish government default on its debt, the Irish central bank, and therefore the Irish taxpayer, would carry most of the loss.

Finance Minister Michael Noonan has already argued strongly that this will make the QE process less effective. But there had been fears that all of the loans would come from national central banks.

There will be some relief that 20pc is from the ECB and risk will be shared by all on that money. Ireland's portion of any loss would be just 2pc.

There is also the precedent of the Anglo- Irish Bank "promissory notes".

These swapped Central Bank loans into government debt, showing that ways can be found around the restrictions. There will be another challenge before the German courts and we can perhaps expect the existing EU borrowing rules to be enforced more strictly, which would seriously hamper any government stimulus, even if the economy improves.

Nevertheless, Ireland, in particular, is well placed to benefit from QE.

The Euro has already fallen, making exports cheaper. The fact that we import most consumer goods means prices may rise faster here, helping the Government in its efforts to get employers to offer wage rises.

It also means that interest rates will stay low for a long time.

There will be renewed pressure on the banks to cut the rates on mortgages and loans to small business.

If this undoubtedly dramatic move by the ECB were also to instil some optimism among the browbeaten peoples of the Eurozone, we might begin to see real results.

Irish Independent

Today's news headlines, directly to your inbox every morning.

Don't Miss