Just "Three Little Words", and not nearly as romantic as the ones Fred Astaire sang about. Then again, how would the markets have reacted if Mr Draghi had cooed "I Love You"? A brief history of "Whatever It Takes" .....

Wednesday 27th July 2016

Just "Three Little Words", and not nearly as romantic as the ones Fred Astaire sang about. Then again, how would the markets have reacted if Mr Draghi had cooed "I Love You"? A brief history of "Whatever It Takes".....

ref:- ""Whatever it takes": four years on from Draghi's ECB pledge", The Financial Times, Capital Markets

Can it really be four years since the European Central Bank president Mario Draghi announced that "the ECB is ready to do whatever it takes to preserve the euro ....."? As cynics might well point out, that particular battle is far from won but there's little doubt that Mr Draghi's words and actions did pull the Eurozone back from the brink of disaster. Nevertheless, the ECB is still facing many of the same issues that it was forced to confront in 2012, and one or two distinctly troubling new ones, The FT offers a brief summary of what's happened since SuperMario's finest hour:

SOVEREIGN DEBT: We may now have become used to negligible yields on government debt even in the bloc's weaker nations, but back then investors were punishing the so-called peripheral countries like Spain and Italy buy pushing the yields that they had to pay on their borrowings out to levels that would have been unsustainable in the long term. The ECB prepared a programme (Outright Monetary Transactions) specifically designed to buy such distressed debt. In the event, there was no need to put the programme into practice  --  the plan itself and of course the arrival of the ECB's much wider QE programme was enough to reverse the hugely damaging widening of peripheral debt spreads (generally, the difference in yield of a government bond in a peripheral nation over it's German Bund equivalent) . Spain's 10yr bond yield in August 2012  hit 7.165%  --  now, it's about 1.11%. Even Italy, not short these days of a fundamental problem or two, has seen its yields fall from 6.3% to 1.2% over the same period.

BALLOONING BALANCE SHEET: In many people's eyes, the ECB arrived much too late to the QE party (six years after the US and UK) but you can't really fault their commitment to it since, not with about 1 trillion euros of asset purchases sitting on their books. Originally designed to buy 60 billion euros in government and covered bonds per month, it has been adjusted to include corporate bonds and expanded to 80 billion euros per month.  The ECB balance sheet will soon top the US Federal Reserve's and Bank of America Merrill Lynch estimate it will hit a total of 3.1 trillion euros by early next year  --  35% of the Eurozone's entire GDP.

INFLATION: Having dealt with spiralling peripheral bond yields, the ECB turned its attention most keenly on low growth and inflation  --  and in this it has been singularly unsuccessful. Monthly inflation has fallen from 2.4% in 2012 to 0.1% last month. Deflation arrived for the first time in 2014 and we've been hovering around zero ever since. The ECB has set its inflation target at close to but not more than 2.0%, which for all the ECB's efforts has looked like pie in the sky for a very long time now. In fairness, like every other monetary authority keen to see a bit of inflation the ECB has not been helped by the tumble in oil prices which should at least have had the compensatory effect of encouraging growth but that hasn't been easy to discern either. By its own estimates, the ECB will continue to miss its target both next year and in 2018.

THE EURO: It seems like the Euro has taken a bit of a battering in recent times, undermined by negative rates and QE. If you're after some inflation and more competitive exports to help growth, that's a good thing (not that central bankers would admit that weaker exchange rates designed to have that competitive effect are part of policy). As it happens, the Euro may have fallen 9% on a trade-weighted basis since January 2014 but over the whole period since July 2014 it has actually risen by about 2%, using the same measure.

So the ECB has had its successes to go along with its less successful policies, but still has to deal with the threat posed by poor growth and near-zero inflation . As we said, there'll be other major problems and plenty of them -- Italian banks? Greece again? European politics? Perhaps the biggest worry is that investors will no doubt be relying on the ECB to sort those problems out, to do "whatever it takes" once again if you will, and as we often say: you can't expect central banks and their monetary policy to do it all for you, especially when their arsenal is beginning to look pretty bare.