Posted January 23, 2015 Steven Wood
On Thursday 22nd January, ECB President Mario Draghi announced that, starting in March and lasting until at least 2016, the ECB would conduct a €60 billion monthly private and public bond-buying program. This was €50 billion per month more than had been expected and, in total, the Quantitative Easing program will likely amount to about one trillion Euros. This means the ECB will join the U.S. Federal Reserve, the Bank of England and the Bank of Japan in launching QE.
The ECB’s goal by launching QE is to raise the region’s low inflation rate, which in December came in at an annual rate of -0.2%. Draghi fears that deflationary pressures (more notable in the drop in oil prices) as well as the lack of growth could trigger adverse secondary effects on both wages and prices. Germany, remembering their hyperinflationary period during the 1920s, has been against such ‘money-printing,’ monetary programs, favouring instead longer-term fiscal discipline involving sustainable spending and debt repayment schemes. Nevertheless, following the ECJ’s decision to legally authorise QE, Draghi was finally allowed to deliver on his promise to do ‘whatever it takes’ to get the euro zone out of its prolonged deflationary period.
The ECB will buy euro-denominated investment-grade securities. The debt of countries that are tied to international bailout programs will be subject to “additional eligibility criteria.” The ECB, however, will not buy more than 25% of any bond issue, or 33% of the marketable debt of any issuer. Since the ECB already owns too much Greek debt, the ECB will have to wait for this debt to mature in July before considering buying any more. Debt that is trading with a negative yield will also be eligible for the program. In the event of a sovereign restructuring or default, Draghi stated that public and private bondholders would be treated equally. Also, 20% of the additional purchases will be subject to risk-sharing agreements, designed to limit the amount of risk the ECB takes on to its balance books. The majority of risk will therefore remain with the national central banks of euro zone members. No more than 25% of each debt issue will be purchased. The maturities of the debt purchases will range between 2 and 30 years.
The markets were eagerly awaiting Draghi’s statement and there were some major moves both before and after QE was announced. One week prior to the QE announcement, the Swiss National Bank removed its peg to the euro, likely in anticipation of QE.
After the announcement, market volatility increased and there was some whipsaw action, particularly in currency markets, with the euro dropping significantly against the sterling and the dollar before retracing some ground. The European markets have rallied too, whilst the 10-year yields on a range of European sovereign debt fell to record lows.