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60bn-a-month to fight deflation and euro crisis – but why is it happening and will QE work? 60bn-a-month quantitative easing programme in a bid to save it from deflation and a low-growth crisis. ECB president Mario Draghi showed his hand today after a leak last night revealed the bank was poised to step up the fight against deflation with a scheme similar to that already employed by the US and UK. He announced at lunchtime that QE will finally arrive for the eurozone.
60bn-a-month of bonds purchased until September 2016, with the aim of lifting inflation back towards the ECB’s 2 per cent target. By buying up the eurozone nations’ government bonds, the ECB will inject extra money into the financial system. It was not revealed how much of the monthly total will go towards buying government debt. Markets had already cheered the prospect, with shares rising late yesterday and again this morning. He revealed that the ECB would buy euro-denominated investment grade bonds, including the government bonds of the currency union’s 19 member states. Draghi said that there was a large enough majority agreement on the need to trigger QE now that it did not need to take a vote. However he added that the decision was not unanimous.
Stock markets’ reactions to the news was mixed, initially rising and then falling back. The euro dropped against the dollar and the pound. Nancy Curtin, chief investment officer of Close Brothers Asset Management said: ‘European QE is set to start with a bang rather a whimper, a fact that will be well received by investors. In reality, Draghi had little choice but to act, and this QE will help provide greater liquidity, and lower the value of the euro to support manufacturing and exports.
However, the eurozone is far from out of the woods. Structural economic issues remain, and all eyes now turn to the Greek election, with concerns that the result may eventually lead to a default and exit from the monetary union – a move which could send shockwaves through investors in the eurozone. QE keeps government bond yields low, eases the cost of servicing national debt, pushes extra funds into the financial system to be invested and lent out, and keeps a currency low – lowering the price of exports for overseas buyers. Launching eurozone QE, similar to the asset-purchasing schemes previously adopted by the UK and US alongside ultra-low interest rates, has been discussed for many years. The ECB has so far held fire on money-printing, something that has been a source of major dispute within the currency union. Advocates of the move say QE is needed to pump more money into the struggling eurozone economy, keep borrowing costs low for troubled nations, encourage business and consumer lending and keep the euro low against other currencies. Critics say that money-printing will let irresponsible economies that borrowed too much in the boom years off the hook – and allow them to avoid necessary austerity measures to get their finances in order.
The eurozone’s powerhouse Germany has been the main critic of QE and its objections created the biggest stumbling block to its arrival. Initially, German fears surrounded the risk of triggering a bout of eventual substantial inflation through printing money. Now with the eurozone seemingly locked into a cycle of stagnant growth and deflation, the concern has shifted. The main fear is problem economies that need to reform will see QE as get-out-of-jail free card. The crunch point is considered to have arrived, however. Figures showed the eurozone economy slipping into deflation in December, with an inflation figure of -0.
Meanwhile, the currency union’s biggest problem child Greece goes into a snap election this weekend, with fears that left-wing party Syriza could be elected and lead the nation to default on its debt. Even in the larger and more stable nations such as Italy and Spain, some people question the merits of the euro, as the union has prevented them from allowing their currency to slide in value to improve competitiveness, as they have done in the past. Quantitative easing does not actually involve printing money, although it is popularly described in this way. Instead, a central bank buys bonds with the extra funds it has created, which essentially puts more money into the financial system. In the UK, this was done through the Bank of England buying up government bonds from investors with money it generated. The exact details of the eurozone plans are still emerging, but they will involve buying up both private and public sector debt. A substantial amount is expected to be government sovereign bonds.