Maybe they aren’t that convincing given that bond yields are already very low and credit spreads are tight.
Banks are still not in a position to lend and there is no guarantee that announcing QE now would help push inflation up in the near term. Draghi may want to keep his powder dry for a time when there might be a greater return on pulling the trigger on QE. At any rate, central bankers must be quite reassured that macro and market volatility is at a lull at present. This could change with stronger US data and upward pressure on market yields. I doubt total returns will be as strong as they have been in Q1.
The clamour for European QE
The ECB kept the market guessing this week with its announcement of unchanged policy at the same time as discussing the possible use of further conventional and then unconventional monetary policies if disinflation is prolonged. There is a certain clamour in the markets for the ECB to do something unconventional and this has been encouraged recently by comments from Bundesbank President Wiedmann and by Draghi himself refusing to rule out QE.
But let’s think about it, what would the benefit of QE be?
In the post-financial crisis there have been (will be) four phases of monetary policy. The first was the aggressive cuts in interest rates that followed the collapse of Lehman Brothers in 2008. This lead to a lower and steeper yield curve. The second was – at least in the US and UK – QE which led to lower long term yields and a flattening of the curve brought about by aggressive purchases of government bonds by central banks. The third has been the attempt to keep intermediate interest rates low and monetary policy expectations well anchored through forward guidance.
The last phase will be normalisation which would entail increases in short term rates and a bearish flattening of the yield curve. Of course, the path of the ECB’s monetary policy has been somewhat different to that of the US and UK because it had a sovereign default problem to try and solve, thus its LTRO policy was aimed at providing enough liquidity to the euro area banking system to allow banks to buy government bonds and thus facilitate a narrowing of credit spreads between sovereign issuers in the same currency bloc.
It was a different form of QE involving an extension of the ECB’s balance sheet (although on a temporary basis) and targeted at reducing government bond yields. It worked. Bond yields are lower and the German curve is much lower than US Treasuries and gilts, while sovereign peripheral spreads today are at their lowest levels since 2010. The ECB has even adopted a form of QE, implying that it will keep interest rates on hold for a very long time.
Why not?
So why the clamour for QE today if much of the benefit of QE has already been accomplished without the ECB doing the same thing as the Federal Reserve (Fed) and the Bank of England (BoE) and the Bank of Japan (BoJ)?
One answer would possibly be based on the argument that it is the stock of liquidity provided by QE that is important rather than the flow.
The Fed, BoE and BoJ have added permanent liquidity through the expansion of their balance sheet while for the ECB, through the LTRO, it has been temporary and is already in decline. A second argument is that the European Economy still needs help because growth is weak and inflation is very low. A third is that the euro is too strong and is threatening the recovery through making euro exports less competitive and that QE might bring the exchange rate lower. A fourth is the sentiment argument.
The announcement of QE would be taken well by investors, it might bring yields and spreads even lower and the exchange rate down, and the link between QE and a stronger economic recovery would be established for the euro area in the same way as it has been established in the US, UK and Japan.
Chris Iggo is CIO of fixed income at Axa Investment Managers
