What’s going on?
Today, Mario Draghi, the head of the European Central Bank (ECB), held his monthly press conference. The big news is that the ECB will not be launching a round of quantitative easing (QE) this month, as many economists had predicted.
Draghi did say that the ECB is seriously considering QE, and will not allow inflation to fall below the 2% mark for a prolonged period.
He also said he “intended” rather than just “expected” the ECB’s balance sheet to return to 2012 levels – in other words, he wants to buy a load more assets.
However, he refused to be drawn on when this would take place, or what assets it would involve, only saying that the situation would be “reassessed in early 2015”. As a result of the disappointment, the euro rose slightly, while share prices in the eurozone slid.
Why does this matter?
The recession in the eurozone has officially ended. But the recovery is still very slow. The area as a whole grew by just 0.2% in the third quarter. And obviously these figures hide the fact that some areas are still stagnating.
Italy didn’t grow at all, and France is now in recession. And even though the likes of Greece are now growing again, they still have huge levels of unemployment.
That’s all bad enough – but many economists also reckon this fragile recovery won’t last for long. Business and consumer confidence is low, and the ECB’s own forecasts suggest growth will be only 1% next year.
Inflation, meanwhile, is expected to average around 1.3%, which raises the threat of deflation in several countries, if not across the whole eurozone. The hope is that QE, especially if it involves buying government bonds, will boost lending to businesses and growth in general.
Could QE help in any other way?
Buying sovereign bonds would help to keep down the cost of government borrowing. That’s helpful because many countries are torn between electorates angry at austerity and demands from Brussels that deficits be brought down.
Recently France and Italy tried to get the European Commission to relax their fiscal targets, in order to boost growth. Both countries backed down eventually, but were able to submit revised budgets based on “optimistic” projections about future growth and revenues.
Greece is also trying to negotiate an exit from the bailout, although it is having problems securing a backup credit line (perhaps unsurprisingly). Lower sovereign bond yields would go a long way to resolving both situations. This would also reduce the risk of another messy confrontation between Brussels and individual countries.
So why on earth hasn’t Draghi done QE yet?
Because the idea it’s politically unpopular in Germany. The Germans are worried that QE might cause serious inflation. They are also worried that if the ECB buys sovereign bonds, then it is in effect carrying out a backdoor bailout of these countries. That might make those countries decide they don’t need to carry out any more painful reforms.
Germany’s representative on the ECB, Jens Weidmann, the head of the Bundesbank, has also argued that QE would only have a limited impact.
In response, Draghi pointedly said during Thursday’s press conference that the ECB could take action even if there were disagreements between members. This suggests that Weidmann is increasingly isolated – though he clearly still has enough power to delay matters.
If Draghi doesn’t follow up on his promises soon, the euro could go a lot higher again – which is exactly what he doesn’t want and what the peripheral countries don’t need.