Eurozone QE

Some thoughts on what may be to come next week

With European governments increasingly keen to balance their fiscal budgets, or at the very least reduce their deficits over the coming years, monetary policy is taking on an increasingly important role.

On January 22^nd, the ECB is likely to announce the commencement of their Quantitative Easing programme, with rumours of an additional trillion euros being added to the monetary base, although the specifics are yet to be thrashed out. Mario Draghi will have to be politically savvy in his wording in order not to further damage bonds with the Bundesbank. The ECB, unlike the Bank of England and Fed, has been reluctant to embark upon a QE scheme, in part due to the complexities of the administration but also due to the reluctance of certain member states.

The Eurozone members will be hoping to use QE and other loose monetary policy, such as maintaining the benchmark rate of 0.05% to stimulate growth across the region.

Member states such as Greece, Ireland and Portugal that received bailouts from the IMF, EU and other organisations have had limited use of discretionary fiscal policy. Conditions of the bailouts required governments to cut budget deficits, particularly primary deficits, in order to move towards a more manageable debt-to-GDP ratio. This has proved successful in reducing deficits but growth is still lagging behind successful European countries such as the UK.

Other countries such as Italy have had to ensure that budget deficits don’t get out of control in order to protect borrowing rates. Italian yields have fallen to 1.86% on January 7^th 2015 just 4 years after touching 7%.

With expansionary fiscal policy not forthcoming, it is the role of monetary policy and the ECB to stimulate growth in several of the Eurozone’s sluggish economies. Although some of the funds will be used to repair balance sheets, as was the case in 2009 in the US and UK, the state of firms’ finances have a much rosier outlook going into 2015. The hope would be that the money that firms receive will be invested in utilising the spare capacity in the Eurozone, driving up employment and growth, whilst at the same time warding off the lingering threat of deflation.

The Euro has already fallen in value from $1.31 to $1.18, over the last two months, which has helped and will continue to aid exporters, while also boosting import prices and introducing much needed inflationary pressure.

Equities should be boosted too by the announcement. The Dow Jones has climbed from 6600 to a New Year peak of over 18000 at the same time that the Fed has pumped over $3.7 trillion dollars into the US economy. While in the same period the FTSE has climbed from 3500 to nearly 7000 in no small part due to the £375 billion that the Bank of England has introduced.