INVESTORS ARE ADDICTED TO THE QE PLACEBO / THE FINANCIAL TIMES OP EDITORIAL

Investors are addicted to the QE placebo

The collapse in inflation expectations is a sign of waning faith in central Banks

Tommy Stubbington


Mario Draghi gave his most forceful plea yet last month for governments to loosen the purse strings to complement the ECB's stimulus, which investors believe is an admission that the central bank is running low on ammunition



Ever since the European Central Bank’s president Mario Draghi began to stoke expectations of further stimulus back in June, investors have been betting heavily on two things: that more quantitative easing is on its way, and that it will not work.

Now that Mr Draghi has delivered his parting shot from the ECB by cutting rates and resuming bond-buying to the tune of €20bn a month, markets have doubled down on those bets.

A key gauge of inflation expectations in the eurozone, which is closely watched by the ECB’s governing council, fell to an all-time low this week. The so-called five-year five-year inflation forward — which measures how much annual inflation markets are pricing in over the second half of the coming decade — sank below 1.11 per cent.

Much analysis of the latest stimulus move has focused on whether Mr Draghi could “over-deliver” by further stoking a rally in eurozone government bonds that has pushed yields to record lows — or at least, not cause it to go into reverse.

On that basis, September’s easing package can be counted a modest success. A bond rally that looked to have stalled ahead of the meeting has since resumed. Many investors are already betting on further rate cuts, or expecting Mr Draghi’s successor Christine Lagarde to assert her authority by beefing up the QE programme.

But for a central bank whose only mandate is to keep inflation below but close to 2 per cent, it is a strange kind of success. The eurozone rate slipped below 1 per cent in September. Stimulus may be good for bond investors’ portfolios, but appears to have little impact on their inflation expectations.

Buying 30-year German debt at a sub-zero yield looks like an odd trade at the best of times. If you expect the ECB to get anywhere near its target over the next three decades, it looks downright foolish.

Richard Barwell, head of macro research at BNP Paribas Asset Management, likens investors to a patient knowingly demanding a placebo: “The bond market is adamant it needs stimulus, but equally adamant it doesn’t work,” he said.

If investors believe monetary easing no longer has much impact — a view shared by a growing number of economists — then why keep doing it?

Mr Draghi pointed out in his interview with the FT last month that tumbling inflation expectations are not confined to the euro area. While it is true that US inflation forwards have also sunk alarmingly this year, it is less clear why the ECB should take comfort. The collapse is a sign of investors’ waning faith in the power of central banks everywhere.

The outgoing ECB head denied the central bank is out of ammunition, arguing more could be done with both interest rates and asset purchases. But Mr Draghi also gave his most forceful plea yet for governments to loosen the purse strings to complement the central bank’s own stimulus. While he would never say so directly, to many investors this sounds like a tacit admission the ECB is running low on bullets.

Markets seem to agree that, at this point, fiscal stimulus offers more bang for its buck than further monetary easing. Hints in August and September that the German government was considering ditching its cast-iron commitment to a balanced budget caused brief bond market wobbles.

A full-blown commitment by Berlin to borrow and spend would no doubt have a much bigger impact on both the economy and the expected path of inflation. Bond markets in Germany and beyond would no doubt feel the pain as they were forced to digest greater issuance of bonds to fund any spending splurge. In that light, the clamour for negative-yielding debt suggests investors are not really expecting much on the fiscal front.

These dynamics are playing out amid an almighty row over Mr Draghi’s final policy moves. Central bankers from Germany, Austria and the Netherlands have all joined the German tabloid press in publicly criticising the ECB’s stimulus package. The boss of Europe’s biggest insurer, Allianz, lambasted the Italian for his “politicisation” of monetary policy.

There is little logic to these calls for higher interest rates. Negative rates and QE have not pushed inflation back to target, but things could always be worse. Without them the eurozone might soon be facing the spectre of deflation. But they are another sign that the negative side-effects of monetary policy are coming into focus as its effectiveness wanes.

If Ms Lagarde goes down the path of further stimulus, the calls will grow louder. Some ECB policymakers may even calculate that causing further discomfort could become the main point of QE and negative rates: dish out enough pain to German savers and Berlin may shift its stance on fiscal policy.

It might just work, but it is a dangerous game, both for an increasingly political ECB, and for bond investors.