European Central Bank’s Bond Conundrum
ECB Faces a Tougher Road in Emulating Fed, Bank of Japan
By Brian Blackstone
Nov. 2, 2014 1:50 p.m. ET
The Federal Reserve just closed the book on its government-bond purchases. The Bank of Japan on Friday vastly expanded its program. Now attention turns to the question of whether the European Central Bank will speed up its printing presses and start buying sovereign debt.
It would be a much tougher road for the ECB. The eurozone’s central bank faces political and practical hurdles that would complicate any attempts to replicate the U.S. and Japanese programs, known as quantitative easing or QE.
The ECB meets Thursday, but it isn’t expected to unveil new measures. At issue is whether any ECB purchases of government debt would lift inflation toward the bank’s target of near 2%. Annual eurozone inflation was just 0.4% last month.
ECB interest rates can’t go lower. That leaves purchases of public and private debt as the main lever to keep borrowing costs down, boost asset prices, weaken the euro and goose inflation.
The ECB is buying some private securities and is open to adding corporate bonds. Officials have flagged government-bond buying as possible, but reached no decision amid doubts such purchases would help the economy without supportive government measures.
One problem: Buying debt in private markets may not generate enough assets to meet ECB President Mario Draghi ’s goal of steering the central bank’s balance sheet toward early-2012 levels. That implies a rise of as much as €1 trillion ($1.25 trillion) from just over €2 trillion now.
When central banks expand their balance sheets—the total value of their assets—they effectively pump new money into the economy in hopes of spurring activity. ECB bond buying started slowly: It purchased €1.7 billion in covered bonds—bank bonds backed by underlying collateral—in the first week.
“They’re running out of time,” said BNP Paribas economist Ken Wattret. “If you want to expand the balance sheet more quickly you have to buy in bigger markets.”
The eurozone’s nearly €7 trillion government-bond market would solve that problem. But many ECB officials are loath to take that step, instead eyeing asset-backed-securities purchases starting this month and the next batch of bank loans in December.
“I don’t think we should in the next few months be considering things like public-sector bond purchases,” though they should be studied just in case, said ECB member Ardo Hansson, who heads Estonia’s central bank, in an interview last week.
Austria’s central banker is hesitant, saying more government investment is a better idea. Germany’s Bundesbank firmly opposes buying government bonds. And no one at the ECB is publicly making a forceful case for buying them. The reasons are twofold. The policy is deeply unpopular in Germany, where it stirs fears of central banks printing money to finance runaway public spending. Opponents also say there is little evidence it would help the weak eurozone economy.
Fed bond buying nudged long-term U.S. interest rates lower, in part because so much borrowing in the country is financed through capital markets. Europe’s financial system is bank-based and therefore would be less responsive to quantitative easing, skeptics say.
There are other problems that bond buying wouldn’t affect. Tax and spending policies are hampering growth in France and Italy. Measures to boost Europe’s growth potential have been largely avoided.
Quantitative easing “is no magic wand,” said RBS economist Richard Barwell. “It’s only about credibility” for the ECB as a central bank determined to meet its inflation goal.
Europe has already had a dry run of sorts with quantitative easing. Mr. Draghi’s pledge in July 2012 to do “whatever it takes” to save the euro, backed by a bond-buying plan that hasn’t been used, led to lower bond yields across the eurozone.
In other words, the ECB got quantitative easing-like effects on bond markets without spending money. But the economy saw little benefit.
If inflation stays near zero, inflation expectations slide and the euro firms, the ECB may have little choice but to buy government bonds.
“It’s a sign of the desperate situation of the euro area that people are so focused on something that will not turn the tide around,” said Charles Wyplosz of the Graduate Institute in Geneva, referring to quantitative easing. Still, he said, “It may help and doesn’t hurt, so why not do it?”
That’s far from “whatever it takes.” But in the end it may be the best argument Mr. Draghi can muster.