Mario Draghi, president of the European Central Bank.
As the European Central Bank president and his Executive Board sit down today to formulate a bond-buying proposal to fend off deflation, one option is to ring-fence the risks by country. While that may win over some of Draghi’s opponents when the Governing Council meets on Jan. 22, it might also shine a spotlight on the lack of unity within the union.
“An absence of risk-sharing could be taken as a bad signal by the market with respect to the singleness of monetary policy and could be self-defeating,” said Nick Matthews, senior economist at Nomura International Plc in London. “However, it may prove to be a necessary compromise to make the design of QE more palatable for Governing Council members, and is preferable to
having to limit the size of the program.”
Investors are banking on Draghi to announce quantitative easing at his press conference after the council meets, with economists in a Bloomberg survey estimating the package at 550 billion euros ($640 billion). What remains unclear is how far he’ll go to mollify critics who say unelected central-bank officials are shifting risk from weaker to stronger nations.
Backdoor Policy
The tension surfaced again yesterday at a conference in Dublin. Irish Finance Minister Michael Noonan said having national central banks buy government bonds would be “ineffective,” drawing a response from ECB Executive Board member Benoit Coeure.“The discussion is how to design it in a way that works, in a way that makes sense,” Coeure said. “If this is a discussion about how best to pool sovereign risk in Europe, and how to make the pooling of sovereign risk take a step forward in an environment where the governments themselves have decided not to do it, then this is not the right discussion.”
Klaas Knot, the Dutch central-bank governor, told German magazine Der Spiegel last week that “we have to avoid that decisions are taken through the back door of the ECB.”
Spiegel reported on Jan. 16 that the latest QE plans envisage national central banks buying the debt of their own country. Frankfurter Allgemeine Sonntagszeitung said two days later they would be liable for at least half of any losses that may arise from buying bonds issued by their own country. Neither publication said where it got the information.
Effects Overshadowed
German Chancellor Angela Merkel signaled yesterday that she won’t stand in the way of Draghi’s plans, saying her only request is that any ECB action this week mustn’t diminish pressure on governments to make structural reforms.“It has to be prevented that actions of the ECB seem in any way to push what has to be done in the area of fiscal policy and competitiveness into the background,” she said at Deutsche Boerse AG’s New Year reception near Frankfurt.
QE is supposed to boost inflation and stimulate growth by pushing investors into riskier assets, including outside the euro area and so weakening the currency.
“If investors realize that the eurosystem isn’t willing to shoulder the credit risk on its aggregate balance sheet, any positive displacement effects are likely to be overshadowed by increasing redenomination risks,” said Elwin de Groot, senior euro-area strategist at Rabobank in Utrecht, Netherlands.
Fund Flows
The increased probability of QE has so far been sufficient on its own to make a mark since slumping oil prices took the euro-area inflation rate below zero. The single currency is trading near an 11-year low against the dollar and fund flows out of the region probably contributed to the Swiss National Bank’s shock decision last week to end a cap on the franc.The ECB has a track record of holding individual euro members to account. Emergency Liquidity Assistance is provided at national central banks’ own risk, and concessions for seven countries on the eligibility of credit claims as collateral were made outside the ECB’s risk-sharing framework.
Limits on QE would help address legal concerns, with European Union law banning the ECB from financing governments, and a ruling from the European Court of Justice on an earlier bond-buying plan still pending. While a non-binding opinion last week signaled that the still-unused Outright Monetary Transactions program is in principle legal, it also pointed to limits to the ECB’s powers.
Increased Incentives
“The treaty hasn’t been written in a way to allow for a mutualization of debt, and the ECB could enter a gray area very quickly,” said Anatoli Annenkov, senior economist at Societe Generale SA in London. “While implementing QE at the national level is signaling the wrong thing with regard to a single monetary policy, a benefit is that any program can be bigger.”Segregating potential losses might also address Merkel’s concern that QE weakens the need for governments to make their economies more competitive.
“You’d increase incentives for governments to push forward with structural reforms,” said Juergen Michels, chief economist at BayernLB in Munich. “You’d also raise the hurdle for a sovereign default, given it’s within the responsibility of governments to keep the central bank stocked with adequate capital.”
The issue of debt defaults is looming ahead of Jan. 25 elections in Greece. Syriza, a party campaigning on an anti-austerity platform that includes restructuring some of the nation’s debt, is leading in polls.
The debate on risk sharing is likely to continue until all 25 members of the Governing Council are sitting together on Jan. 22. No deal is done, and there is no consensus on limiting risk-taking to the balance sheets of national central banks, Italian newspaper Il Sole 24 Ore reported on Jan. 18.
“A broad-based asset-purchase program from the ECB now looks a fait accompli,” said Frederik Ducrozet, a Paris-based economist at Credit Agricole SA. “One might as well maximize its chances of success.”
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