Widely expected decision: The ECB announced today an expanded asset purchase programme that will add the purchase of sovereign bonds to its existing private sector asset purchase programmes, the asset-backed securities purchase programme (ABSPP) and the covered bond purchase programme (CBPP3), which were both launched late last year. Combined monthly purchases will amount to €60 billion. They are intended to be carried out until at least September 2016 and in any case until the Governing Council sees a sustained adjustment in the path of inflation that is consistent with its aim of achieving inflation rates below, but close to, 2% over the medium term.
The devil is in the details: This decision was widely priced-in the markets, with bonds yields in periphery countries easing to new lows already before the decision was announced. The main uncertainty was about the details of the programme, particularly on how the ECB would deal with two issues:
- Risk sharing of sovereign debt: Several countries have argued that the risk sharing on the bond buying should be limited,. For example, should the ECB buy Greek debt and Greece defaul on the debt, the risk should be borne by the Greek Central Bank. The ECB has responded to this issue by accepting that it will only fully share the risk on 20% of the programme and the remaining 80% will be borne by the national central banks. In any case, President Draghi has stated that in case of default the national central banks should be able to deal with the losses through their normal buffers. Adding to this, given that national central banks’ liabilities are fungible, i.e., interchangeable (euro coins and notes are accepted everywhere in the euro area regardless of where they are coined or printed), the issue of risk sharing is not very relevant unless one country effectively leaves the euro.
- Greek elections: the point above brings us to the issue of whether Greece will default on its debt and also exit the euro area. Only in these circumstances would the risk sharing above be necessary to avoid a contagion from the crisis in Greece. More cynical minds might also view the risk sharing demand by Germany and other countries as a means to protect their central banks should THEY want to leave the euro area! But that is unlikely and the most pressing issue is whether the extreme-party Syriza will have enough votes to form Government on its own, which would raise the risk of a messy Greece’s exit. At this stage, though, Syriza has significantly toned down from its early days, as it dropped the threat of an exit and unilateral debt default. In any case the ECB has cleverly sidestepped this problem by limiting its exposure to Government debt to 25% per issue and 33% per issuer-country. Draghi stated that, given the ECB current exposure to Greek debt, it should only be able to buy more Greek deb by July, well after the elections that will take place on Sunday.
Effectiveness up to a point: the major question of QE, however, is whether it will be effective to support the economy. The ECB will buy debt from all countries according to their contribution to the ECB’s capital. This brings home rather strongly the point that it is not supporting Government debt, but rather freeing the financial system from Government debt, therefore opening up the option to increase lending to the private sector. This should be the main channel through which QE will work. The yields on the bonds should also fall, with contagion to yields on other assets, which should reduce the cost of finance. Finally, the ECB hopes that today’s decision will boost confidence and lead households and firms to spend more.
However, the role of the ECB supporting growth is sharply limited by the fact that trend growth in the euro area is rather limited. In order to take-off, the economy probably needs to be more flexible and further reform, notably in the service sector and the labour market, is probably required.
Today’s news are good from a business cycle standpoint, but they do absolutely nothing to solve the more important issue of structural growth. In that field the ECB can only support the economy temporarily, in the hope that this will give Governments more time to pursue much needed market reform.