Remember, it's the ECB's big day tomorrow -- general consensus is : They want to take action .... They're going to take action .... just probably not yet. It's a little awkward, you see .......

Wednesday 7th September 2016

  

Remember, it's the ECB's big day tomorrow  --  general consensus is: They want to take action .... They're going to take action .... just probably not yet. It's a little awkward, you see .......

ref:- "ECB reluctant to face tough debate on QE" , The Financial Times, International section.

As a measure of just how difficult it is to conduct one monetary policy for a single currency bloc of 19 constituent nations with vastly different needs and desires, tomorrow's likely "no change" decision by the ECB would seem to sum up things nicely. In the face of continuing low growth and inflation, not to mention an unsettling political climate, it's a widely-held view amongst economists that the ECB and its president Mario Draghi (he of "do what it takes" fame) are keen to extend its bond-buying programme beyond March 2017. More to the point the experts are pretty confident that it'll happen, too. The betting is however that not only will it not happen tomorrow but most likely the ECB will be very vague in discussing future steps. 

We were discussing only the other day how the so-called "capital key" means that the amount QE asset purchases of each nation's debt must reflect the size of that nation's GDP  --  or in other words, Germany has the largest economy in the Eurozone and therefore the Bundesbank must buy the largest amount of its sovereign debt. It equates to about 25% of total QE purchases .... and that's becoming a big problem.

Assuming for a moment the German authorities were happy to keep buying their share of the QE programme (they're not, but we'll come back to that), very soon there will not be enough available bunds left for them to buy anyway. Germany's desire to maintain a fat budget surplus means that it has neither the need or desire to issue vast amounts of bunds as some more indebted nations might. Moreover, the current rules state that central banks should not purchase more than 33% of each issue, and that no bond yielding less that the ECB's -0.4% discount rate is eligible. That's a big slice of potentially available paper ruled off-limits.

If the ECB is to extend their buying beyond the current March 2017 end-date, as most economists believe, then clearly something's got to give. Any adjustment to current guidelines brings its own problems, not least the purchase of the most expensive sovereign bonds yielding less than -0.4% opens up the chances of the Eurozone's individual central banks incurring heavy capital losses. But the favourite, doing away with the capital key and allowing proportionately larger purchases of debt from the weaker, more indebted nations, provokes a cold response from the likes of Bundesbank president Jens Weidmann and his allies. For him, it blurs the line between MONETARY policy and FISCAL policy. The electorate might put it more simply: the weaker states would be getting funding from the more responsible ones via an ECB-imposed back-door.

There is also considerable debate over the fundamental efficacy of such radical measures as QE. For all those who believe that an extended bond-buying programme will soothe fears about persistently low inflation and growth, there seems to be a smaller but growing band of those who point out that it hasn't done much to help so far (watch out for a new raft of ECB forecasts at the press conference tomorrow) .

Whichever way you look at it -- but most of all politically -- the decision on additional stimulus and an extension to QE is a potential minefield. Which is why those in the ascendant  at the ECB and who favour action will PROBABLY hang fire tomorrow. They'll have to find a way of placating the Germans and their friends pretty quickly however. If the programme is to be extended beyond March 2017, then you'd think that everything would have to be in place by the December meeting at the latest. It'll be fascinating to see how enthusiastically the Bundesbank can continue to tow the ECB party line despite growing domestic pressures and its own fundamental misgivings.