QE

“The European Central Bank today announced that it has allotted €129.8 billion in lending to the real economy, through its second targeted longer-term refinancing operation (TLTRO). This exceeds the €82.6 billion lent through the first such programme, but does not make significant inroads into the demand and deflation problems faced by the currency bloc.

The TLTRO provides cheap finance to Eurozone banks on the condition they lend to the real economy. The ECB intended to lend €400 billion across two rounds, but ended up reaching just half that. The programme is supposedly targeted at real-economy activity in order to tackle the central problem of weak demand, rather than inflating asset-price bubbles in financial and property markets, which many suspect of quantitative easing in the UK and US. However, TLTROs only work if real-economy investors believe the demand will be there for the production they invest in. And the demand is only there if consumers and businesses feel more confident, meaning that raising prices in asset markets such as property can actually be an effective, if inefficient solution: while it does not tackle the root cause, at least its effects are powerful.

The results of this operation are crucial in determining whether or not the ECB will carry out full quantitative easing in the new year. So far, it has used other unconventional measures such as negative interest rates, asset-backed securities purchases and TLTROs to avoid the difficulties inherent in agreeing a government bond buying programme between 18 central banks with different agendas. Waiting for the results has bought the ECB stalling time before launching QE – during which the problem has become far worse, with inflation falling further and growth forecasts being revised down. Today’s data make full QE significantly more likely: the ECB would like to increase its balance sheet to €3 trillion, but reaching that target will be difficult if not impossible without expanding the range of instruments available to it.

We expect some extension of corporate and eventually sovereign bond purchases. However, a new sticking-point is the return of the Greek crisis: with a strong likelihood of a debt haircut should the left-wing Syriza party take power, the ECB as a key creditor will find government bond purchases less palatable. Some workaround may, then, be necessary. Harder to predict is whether QE will have an appreciable effect on demand. Cebr does not expect it to solve the weak demand problems alone. Necessary accompaniments will include structural reforms and a measure of fiscal loosening by those states that can afford it – however, Germany has just published its budget, which is now balanced and therefore tighter than it has been so far. Some may argue therefore that the ECB has done more than its share already. However, its critics are unlikely to be appeased unless it takes the big step.”