European Central Bank quantitative easing likely to disappoint
While ECB bond buying will help corporations borrow by making bond markets more generous, it will not rebuild capital in the banking sector
Rarely has a major market event been as expected as quantitative easing from the European Central Bank; rarer still has something been so likely to underwhelm.
Almost everyone expects the ECB to announce a full-fledged QE programme at its Thursday meeting. Even French President Francois Hollande, who told business leaders on Monday that sovereign bond buying, long discussed, would become reality.
Markets expect the ECB to announce €600 billion (HK$5.38 trillion) in bond buying, according to a Reuters poll, while economists are assigning a 90 per cent probability to QE.
Reports suggest the bond buying may be delegated to national central banks, rather than sitting on the ECB's balance sheet. This tactic in part is intended to blunt criticism of QE from Germany and elsewhere and to dampen any suggestion that bond buying amounts to direct government monetary financing by the ECB. While perhaps offering a polite fiction that the euro project will continue apace, the idea that the risks of QE might not be shared among member states sends an unsettling message.
It is unclear if Greece would take part, a thorny issue given speculation that its Sunday election will set the stage for dickering over debt terms that could end in default or a euro zone fracture.
While the markets look at the threat of deflation and a recession in the euro zone and take QE as a given, opposition in Germany from the Bundesbank and government is still real.
Indeed driving the euro lower is one of the points of QE, as is driving risky assets like equities and corporate bonds higher. To meet those goals, the ECB will have to deliver a clearly enunciated, large and detailed plan.
Beyond the issue of the size and composition of the programme is whether QE is the right tool for the job at hand. Using a very large screwdriver to cut wood is only marginally more effective than using a modest-sized one.
For QE to work, it needs to impact consumption through the wealth effect, as those whose stocks and bonds are made more valuable spend some of the proceeds.
That is almost certainly going to have a diminished effect in Europe compared to the US, partly because of a lower propensity to spend asset-based wealth and partly due to the very real uncertainty felt by asset owners in places like Italy and France.
As for corporations, they are more likely to respond to government reforms and stimulus than monetary policy. It is very hard to see a capital expenditure boom on the back of QE.
And while QE will to a certain extent help corporations to borrow by making bond markets more generous, it does nothing to rebuild capital in the banking sector. In the euro zone, central banking is hard, but politics still harder.
The measure of the success of the enterprise, then, is dangerously close to being delegated to financial markets, putting the ECB in a position in which no sensible central bank ever wants to find itself.
The Swiss about-face demonstrated that central bank promises are highly conditional and power is limited, even where their ability to print money is not in question.
