THE WORLD AWAITS DRAGHI - QE AMOUNT WILL BE KEY
By Ruma Dubey
Mario Draghi, the President of the European Central Bank (ECB) much be a very stressed out man today. The eyes of the world are on him – what will Draghi do tomorrow; will he announce a stimulus program or just talk some more brave words?
Actually, the time for talk is over and it’s time for action. It is assumed that stimulus in the form of bond buying will actually achieve a miracle – fight deflation in Europe while announcing a stimulus which has to be generous enough to impress investors, without ruffling feathers of the conservative ECB members. And oh yes, Draghi, with this program has to also bring out Europe from this slump! And all this from a Bond buying program, eagerly anticipated tomorrow.
This is truly walking on thin ice, the ECB chief will not know where he could go down into deep waters. Europe is suffering from deflation, unemployment in double-digits and ongoing pain in Greece, Spain and Italy. Greece will go to the polls on 25th Jan and the suspense persists – will it stay back in EU or want to opt out?
It is already assumed that the bond buying is a certainty. Last week, in a surprise move, anticipating a stimulus from the ECB, the Swiss National Bank abandoned a ceiling on the Swiss Franc’s value against the Euro. And taking a preemptive step, the Denmark’s central bank cut interest rates ahead of tomorrow’s ECB move. The question is not whether or not bond buying or Quantitative Easing (QE) or money printing, call what you may, may happen; it’s a certainty but what we need to know is how big would be the QE, how it would be designed and more significantly, would it be enough to overcome deflation and stall Eurozone’s free fall.
Draghi’s main concern would be Germany. He has already had an informal meet with Angela Merkel, maybe trying to take her into confidence, get her approval before the announcement tomorrow. It is a well-known fact that Germany’s Bundesbank does not even like the word ‘Quantitative Easing’ as it equates it to dole or a largesse to undeserving economies, who have been frivolous, with the German taxpayers paying up for their liabilities. And that is why the words doing the rounds is that we might see Draghi making many concessions when it comes to Germany, farming a QE which is conservative, with limited risk and not allowing bond buying of countries which have the lowest credit ratings.
The news is that politics might be a bigger decision maker than economic considerations. And if that indeed turns out to be the case, it is widely stated that the ECB might cap the bond buying at 500 billion Euros or US$ 600 billion. This might prove to be too small to be truly effective when the need is for twice this amount. Most feel that an open-ended QE is what will work – a do-whatever-we-can attitude like the Federal Reserve. But if Draghi puts a cap and announces a smaller amount, the markets world over might be in for a rude shock, except maybe Germany.
Things to watch out for at tomorrow’s ECB policy by Draghi:
- Pay attention to the total purchase size – there are estimates from $600 to $635 billion.
- Will it be monthly and if yes, would it continue along a predetermined period or like US, will it be linked to economic data like inflation and unemployment?
- Bond buying will include what – Govt bonds, other debt instruments or a mix of both.
- Pay attention to the word – limited risk-sharing. Will the bond buying limit risk-sharing by having national central banks buy the debt of their own countries?
- Would purchases be based on ECB’s capital key - that’s the key word in this policy. This means would it be equivalent to the size of the economy? If that is the case then Greece would be excluded as its bonds do not meet any quality criteria.