Ever since the euro crisis began, one of the key fights has been over money printing.
Most economists wanted the European Central Bank (ECB) to follow the US Federal Reserve and the Bank of England by printing money to boost demand and create growth. They also argued that it could also help drive down bond yields, making the huge debt burden that many countries faced easier to deal with.
However, the Germans didn’t agree. They feared that it would drive up inflation. In their view, having the ECB buy the debt of countries would reduce the incentive for them to reform.
For a long time Berlin was able to block action. But eventually it let ECB boss Mario Draghi start buying bonds.
The past nine months have largely vindicated the supporters of quantitative easing (QE). Growth is starting to return to the eurozone. Meanwhile, inflation is at a record low, thanks to low energy prices.
As a result, Draghi has been dropping large hints about speeding up the printing presses. On Thursday, he gave his most dovish press conference yet.
However, even if he wanted to delay, he doesn’t really have a choice. Here’s why.
Greek farce continues
Greece has fallen out of the headlines after the summer’s farce. To recap, after the Greeks voted to reject austerity, the government decided to agree a deal anyway. Despite this, it won a victory at last month’s election.
However, in order to get the money, it has to push through a large number of reforms. While it is making progress, this is taking much longer than anyone thought, with only 14 out of 48 implemented.
As a result, its creditors are starting to lose patience. This week, a leaked copy of a report suggests that they may delay the release of the promised funds by at least a month. While neither side has the courage to walk away (yet), the longer this goes on, the more tensions will start to rise.
Of course, it’s not only Greece that is a potential trouble spot for Brussels. Portugal is another country that could force the ECB to act.
The latest election result was inconclusive with the government losing its majority. The obvious solution was a coalition between the major parties. However, the opposition Socialists has shocked everyone by trying to form an anti-austerity conclusion with two other parties.
To a lot of people’s anger, Portugal’s president has said that he won’t allow this deal. However, it looks like the main conservative party may not be able to govern. This could result in fresh elections, which could possibly bring a new government to power.
Finally, Italy and Brussels are arguing about Rome’s plan to ease up on debt reduction. While Italy still plans to run a surplus, the latest plans include smaller spending cuts and reductions in some taxes.
It is also planning to increase the maximum cash purchase to €3,000. Cash payments of more than €1,000 were banned in 2011, in an effort to crack down on tax evasion.
Uneven growth, risk of deflation
The ongoing controversy over fiscal policy wouldn’t be that bad if growth was stronger. This would help boost consumer spending, cushion the impact of budget cuts and allow both sides to keep kicking the can down the road.
However, while growth is clearly positive in most countries, it is still very weak. Looking at the latest survey data, Capital Economics thinks that the eurozone grew by around 1.6% in the third quarter. This is not enough to reduce unemployment, which remains high at 11%.
What’s more, the average hides the fact that many countries are being left behind. While Spain continues to do well, Greece is expected to see its GDP fall by at least 4% due to the fallout from the summer’s crisis. Even France and Italy have seen industrial production go down during the summer.
There is also the nagging question of deflation, with prices declining in September compared with the same time last year.
Of course, a large part of this is due to the dramatic falls in energy prices, which should help reduce pressure on firms and leave consumers with more money in their pockets. However, core (non-energy) inflation is still relatively low at 0.9%. This suggests that it is partly down to a lack of demand (bad deflation).
What Draghi will do
The low inflation gives Draghi all the ammunition he needs to loosen monetary policy further. It looks like he is going to take full advantage of it.
In his monthly press conference, Draghi said that the “strength and persistence” of the “factors that are currently slowing the return of inflation to levels below, but close to, 2% in the medium term require thorough analysis”. He also pledged to re-examine “the degree of monetary policy accommodation” in December.
In plain English, this means that he is almost certain to loosen policy. One option is to lower the main interest rate into negative territory (it is currently 0.05%). However, while some central banks (such as the Swiss and Swedish banks) have begun experimenting with the idea, more QE is more likely.
At the moment, the ECB is buying €60bn of assets (mainly sovereign bonds) each month. This could be easily increased. Draghi could also formally extend the date at which the money printing ends, currently September 2016.
When Draghi does announce further monetary loosening, you can expect European shares to increase, especially those in peripheral markets such as Greece.
While Greek shares have rallied by 30% since their bottom in August, there is plenty of room to go since they trade at a large discount of nearly 40% to their book value. You can buy into Greek shares through the Paris-listed Lyxor Athens ETF (Paris: GRE).