The Quantitative Easing ends today

As Mario Draghi announced on June 13th, the EBC  bond-buying scheme known as quantitative easing won’t continue for 2019.

All good things come to an end; and the Qe has been a good thing for many years. The ECB unconventional monetary policy which started in 2015 with the aim of slow down  deflation and  crisis has pumped more than two trillion euros into the EU’s economy. After a €30 billion monthly purchases, in September the programme has been wound down to €15 billion a month , in order to cautiously being stopped at the end of December. ECB argues the policy brought to stabilize the eurozone in the wake of the financial crisis.

How does Qe work ?

Through the increase and decrease of interest rates , central banks’ ordinary role is to  keep an eye on the inflation rate. After the Lehman’s bankruptcy , bank and stock market regulation has changed in order to lower the risk and protect people’s money. Here it comes the Qe, to combat “the disinflationary forces that intensified in mid-2014”[1].  Mario Draghi promised to do “Whatever it takes” to exit from crisis mode.  How his challenge has been done? The ECB tried to explain the Qe through doodles. In few words, the European Central bank buys bonds from banks; this increases the price of  bonds and creates money in the banking system. As a consequence, a wide range of interest rates fall and loans become cheaper. Indeed, businesses and people are able to borrow more and spend less to repay their debts. As a result, consumption and investment receive a boost providing economic growth and job creation. As prices rise, the ECB achieve an inflation rate below, but close to, 2% over the medium term.

What have been done?

The ECB was still light years behind the FED , where first Bernake, then Yellen wanted credits for their QE and zero interest rate. But once Draghi & Co started, they didn’t hold back. The situation in the eurozone has clearly improved from 2015.

Inflation was putted on course to meet its target of being slightly below 2% and Eurozone activity accelerated. Last July at the ECON committee, ECB’s president affirmed: “the measures taken since mid-2014 will have an overall cumulative impact of around 1.9 percentage points on both euro area real GDP growth and inflation for the period between 2016 and 2020.” Qe contributed 0.75 percentage points a year to the average 2.25% annual growth rate. Schermata 2018-12-30 alle 13.15.49The ghost of deflation, which came back few times till May 2016, has been defeated. Eurozone economy is healthy and grew at a rate of 2.1% in the second quarter of this year. The unemployment rate, 8.1% in August, is at its lowest level since 2008 and the employment rate has increased of 9.2 million. Revenues , consumption and investments are boosting and the goal of about 2% inflation rate was achieved: in September it was 2.1%. If the Qe is good for Eurozone’s health, why stop it? 

What does the end of Qe mean?

The end of Qe is not the end of the world. On the contrary, the end of the Quantitative Easing is the way back to a more normal financial world, even if a way back to a “before-Lehman world” is not possible, since banks and stock markets have strengthened regulations.

The end of Qe doesn’t only mean that deflation has been won, but also that the economic growth doesn’t need an external support anymore. In fact, the Qe, through the PSPP (Public sector purchase programme), buys government bonds (which are a benchmark); it lowers middle and long terms bond yields, reducing the cost of money even on long maturities.

The world post Qe: what’s next?

The end of Qe is just “the first step in a gradual normalisation of monetary policy”[2]. At the 13 June press conference, the Bank signaled that it will wind the program down gradually: from October to December the monthly purchases have been reduced to 15 millions. Once, the purchases end, key interest rates will remain unchanged “at least through the summer 2019”.  Alongside this gradual plan, on 13 December 2018, the ECB  confirmed it will stop purchasing more bonds while maintaining its reinvestments in place : “The Governing Council intends to reinvest the principal payments from maturing securities purchased under the APP for an extended period of time after the end of the net asset purchases, and in any case for as long as necessary to maintain favorable liquidity conditions and an ample degree of monetary accommodation.”  So,  The ECB’s support will not suddenly disappear, it will be reflected on the reinvestment of existing QE money once bonds mature.

Geopolitical factors are a prominent risk

Now that the QE has come to an end,  all 19 euro zone states will have to reorganize themselves. The main impact will be felt in the fiscal sphere, with a reduced demand for government bonds likely to push up bond yield spreads and increase government refinancing costs, particularly for the highly indebted eurozone periphery. Italy , which was the major beneficiary of Qe, is back on the front burner. Starting from January, Italian bond yields will lose their major buyer and they have to rely on private investors.  The persistence of uncertainties have also been fuelled by President Macron’s promise minimum wage hike in response to violent protests of last weeks; that move puts France on a potential collision with Brussels over its debt. The view to the European Parliament elections coming up next May will increase the political pressure even more. Draghi  has acknowledged  all these events that -together with the threat of protectionism, vulnerabilities in emerging markets and financial market volatility- become a concern when changing the monetary policy. But “investors’ confidence will be the key next year”[3]. But next year is tomorrow and furthermore, it’s Euro’s 20th birthday.

Rebecca Katerina Gutmann

 

[1] Peter Praet, XIX Conference, 14 March 2018

[2] Antoine Lesné, head of EMEA strategy and research for SPDR ETFs at State Street Global Markets

[3] Luca Cazzulani, deputy head of fixed income Strategy at UniCredit.

References 

https://www.reuters.com/article/us-italy-markets-bonds-analysis/italy-needs-to-woo-private-bond-buyers-as-ecb-bows-out-idUSKBN1OI18N

https://www.ft.com/content/aee82ea2-5b5e-34f0-99c3-ace312eb00c1

https://www.fitchsolutions.com/country-risk-sovereigns/economics/end-qe-risks-italy-and-eurozone-periphery-15-10-2018

https://www.ecb.europa.eu/press/key/date/2018/html/ecb.sp180314_2.en.html

https://www.ilsole24ore.com/art/mondo/2018-06-06/bce-vicina-all-annuncio-fine-qe-e-l-euribor-comincia-salire-093824.shtml?uuid=AE634K1E

https://www.investmenteurope.net/news/4000196/ecb-announces-qe-programme

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