ECB has one last chance to save euro with bond purchases
Ultimate survival of the single currency is at risk if policymakers fail to defeat deflation in the euro zone and get the economy back on its feet
After dragging its feet for the past five years, the European Central Bank has finally placed its ultimate policy bet with a government bond-buying programme designed to pump €1 trillion (HK$8.7 trillion) of new money into the deflated euro-zone economy.
Quantitative easing has finally arrived in euro land.
But it is far from certain that the ECB's cascade of cash can get the economy back on its feet. It is hard to shake off nagging doubts that it is all too little, too late to save the economy and the single currency. With political risks reaching crisis point again over Greece, another euro-zone hard landing could be on the cards fairly soon.
At first glance, the scale of the quantitative easing programme looks impressive. It aims to pump €60 billion a month into the economy between now and September next year. It looks good on paper, but the ECB has a lot of catching up to do on what could have been achieved if the move had been adopted much earlier.
Five years on from the start of the global crisis, the relative sizes of the US Federal Reserve and ECB balance sheets go a long way to explain why the US economy has fared so well and why the euro zone has sunk into a deflationary hole. It contrasts a wide gulf between policy success and failure.
The Fed was quick off the blocks to embrace quantitative easing, more than quadrupling its assets in the space of five years through its bond buy-back programme. It delivered a huge amount of cheap cash to consumers, businesses and investors, helping to spark economic recovery and hard-pressed financial markets to rally. A steady economic upturn and an extended bull run for stocks and bonds have put the US in an enviable position - and it is all thanks to the Fed.
Bizarrely, given the euro zone's dire economic circumstances, the ECB turned the other way, allowing its balance sheet to shrink by about a third in the past three years, squeezing credit hard and leaving recovery to wither on the vine. Consumers, businesses and investors have been starved of crucial funds that might have turned the tide for recovery much earlier.
The central bank must make up lost time after years of procrastination over quantitative easing, but its blueprint for recovery hardly inspires confidence. The plan to get the balance sheet back to 2012 levels around €3 trillion falls well short of €4 trillion needed to make any sort of dent in deflation. A sustainable recovery that properly energises the euro zone could take much more.
Thankfully, the ECB has left its strategy open-ended, promising to keep its quantitative easing coffers open until deflation is defeated and a sustained upward adjustment in inflation is achieved.
Given severe headwinds posed by biting government austerity cuts, it would be no surprise if the ECB's balance sheet ultimately rose above €5 trillion in the next five years. And that will put intense pressure on the single currency.
A flood of euros into the financial markets will debase the currency in investors' eyes. The US dollar lost 40 per cent of its face value in the wake of quantitative easing by the Fed and a similar fate awaits the euro.
With US quantitative easing reaching its conclusion and a similar move by the ECB in its infancy, the euro looks set to trade back down below parity against the dollar this year. And if the going gets really tough, a retest of the historic low of 82.4 US cents cannot be ruled out.
Quantitative easing is the last chance for euro-zone policymakers to defeat deflation and put the economy back on the road to recovery.
If they fail, the political bindings on monetary union and the euro will come undone. If those bindings completely fail, it is less a question of whether the euro sinks or swims, but ultimately how long the euro survives.
