The long-awaited move of the European Central Bank finally came yesterday afternoon. Mario Draghi announced from ECB’s Press room in the Frankfurt tower that the Eurosystem, the central banking system of the euro area, will purchase bonds issued by governments and other European institutions at a rate of around €60 billion a month. Obviously the target is to revive the stagnating Eurozone economy by injecting more liquidity in the financial system, wake up the falling prices and avoid negative inflation and why not lead the euro parity with the rest of major currencies to more competitive levels. On Wednesday the Italian Prime Minister Matteo Renzi, speaking from Davos, said that the ECB has to target the parity between the euro and the dollar.
Germany, despite resenting the extension of the quantitative easing program to include government bonds she finally said ‘yes’. Berlin insists though that the ECB by buying sovereign debt from the big spenders of the south will dilute the will of those governments to restructure their economies by introducing unpopular ground-breaking measures to make their countries more competitive. This time however Berlin limited itself to pointing the risks but didn’t block the program of government bond purchases.
Draghi asks the politicians
Of course Draghi himself shares the opinion that politicians have to do more. He has stated that “Monetary policy is focused on maintaining price stability over the medium term and its accommodative stance contributes to supporting economic activity. However, in order to strengthen investment activity, boost job creation and raise productivity growth, other policy areas need to contribute decisively. In particular, the determined implementation of product and labour market reforms as well as actions to improve the business environment for firms need to gain momentum in several countries. It is crucial that structural reforms be implemented credibly and effectively as this will raise expectations of higher incomes and encourage firms to increase investment today and bring forward the economic recovery”.
But takes the right actions
Such measures however present insurmountable political problems and their introduction may lead to uncharted waters. Italy and France are already in the political danger zone. Marine Le Pen’s National Front has gained momentum and she aspires to contest the Presidential election in 2017, while the Beppe Grillo’s Five Star Movement is the largest political party in Italy and he is a comedian.
Not to say anything about Greece, where the unpopularity of the austerity and the reform policies imposed on the poor country during the past five years led to present day problems. The polls now predicting SYRIZA, a left-wing party with an extremist group segment, to gain the first place in this Sunday’s election. It’s the same in Spain where the popularity of the unconventional left-wing Podemos movement is skyrocketing.
In view of all that Draghi had to act, because the politicians are unable to perform their part. Nonetheless, he decided to do what every other central banker in the developed world does. He had to go ahead in order to save Europe from the phantoms of stagnation and deflation that may lead to an unprecedented recession. The central bankers of the US and Britain started buying government bonds right after the financial crisis of 2008-2009 and both those economies are now growing at decent rates. The Bank of Japan is doing exactly the same for some months now, but with poor results just because it delayed its action.
In short Draghi announced yesterday a program of purchases of government and private sector bonds of €60 billion a month starting from March 2015 and going up to September 2016. This means the ECB will spend around €1.14 trillion until inflation moves upwards close to the benchmark target of 2%. This is more than the financial markets expected and as a result the euro/dollar rate dived abruptly yesterday afternoon towards 1.14. Understandably the more money the ECB says it will print and circulate the less its foreign value will be.
Cheaper euro will help
Of course the cheaper euro will surely help all Eurozone countries to export more products and services and thus help their economies start growing again. France and Italy have being asking for a cheaper euro for years. As noted above, Matteo Renzi observed from Davos that a one to one parity between the American dollar and the euro is needed to support the ailing economy of his country. Apart from the cheaper euro, Draghi’s announcement had instantly one more positive effect. The yield of the Italian and Spanish debt paper fell rapidly. The rate of return on the Italian ten-year bond dropped to 1.59% and for the Spanish title to 1.44%. This means that the two governments can now borrow in the capital markets at lower interest rates.
Draghi also managed to keep the government bond purchases program centrally financed by the ECB itself, and not by the national central banks. In this latter case the hypothetical losses would have been decentralized and borne by the national banks and ultimately by the governments which were supposed to be supported by this program. In such a case the Eurosystem would have started to fall apart. According to the decision of ECB’s Governing Council however the only case that loss sharing would not really occur, is in the case of additional purchases by national central banks of assets issued by European institutions, like the European Investment Bank or the European Stability Mechanism.
Draghi was adamant about that. He said plainly “The ECB will buy bonds issued by euro area governments, agencies and European institutions in the secondary market against central bank money…”. In reality this means the ECB is to acquire, pool and hold sovereign credit risks from all over the Eurozone. Truly this is not very different from a Eurobond because in both cases the risks are mutualised. It’s even more interesting that the German reaction to this new program was restricted to the timing of its application. Draghi explained that the conceptualisation of the package was unanimous in the Governing Council, while only the timing of its realisation was decided by a majority, so massive that the issue was not needed to be put on a vote.
All in all it seems that Berlin finally understood that the Eurozone has been created for everybody and not only for Germany.