Coverage: ECB announces stimulus

The European Central Bank is looking to help the European economy grow more quickly by purchasing assets well into 2016.

The Wall Street Journal had this story by Brian Blackstone and Paul Hannon:

The European Central Bank said Thursday it plans to purchase over €1 trillion ($1.157 trillion) in public and private sector bonds by the fall of 2016, a landmark decision aimed at combating stagnation and ultralow inflation in a region that has emerged as a top risk to the global economic recovery.

ECB President Mario Draghi said the ECB will buy a total of €60 billion a month in assets including government bonds, debt securities issued by European institutions and private-sector bonds. The purchases of government bonds and those issued by European institutions will start in March and are intended to run through to September 2016, Mr. Draghi said. The risks associated with the bonds of EU institutions will be shared among eurozone central banks, but purchases of other government bonds won’t be subject to loss sharing, he said.

Mr. Draghi said bond purchases might continue beyond September 2016, and until there are clear signs that the annual rate of inflation is rising toward the central bank’s target of just below 2%. The ECB also lowered the interest rate it charges on its four-year loans to banks by 0.10 percentage point.

USA Today’s Paul Davidson, Kim Hjelmgaard and Donna Leinwand Leger had these details about the state of the European economy and its current struggles:

The eurozone economy likely grew less than 1% last year, economists estimate, after emerging from recession in 2013.

The program, called, quantitative easing, or QE, is aimed at holding down already low interest rates and filling bank coffers to spark more lending, juicing the economy. They’re also intended to further push down the euro, boosting European exports, and channel more investments into stocks to drive up markets.

The ECB finally pulled the trigger on QE after consumer prices in the region fell 0.2% last month. Persistent deflation can prompt consumers to put off purchases, triggering further price declines and recession.

“Inflation dynamics have continued to be weaker than expected,” ECB president Mario Draghi said at a news conference.

Carl Weinberg, chief economist at High Frequency Economics, says the bond purchases help but “QE does not address the key problem faced by the euroland economy — an undercapitalized banking system. Until the banks are fixed and lending again, there cannot be any sustained or meaningful economic growth.”

Jeff Black and Simon Kennedy wrote for Bloomberg that investors are selling currency in response:

Investors reacted by selling the euro and buying European stocks. The shared currency declined to an 11-year low, losing 2.1 percent to $1.1370 at 7:30 p.m. in Frankfurt. The Euro Stoxx 50 added 1.7 percent. Athanasios Vamvakidis, head of G-10 foreign-exchange strategy at Bank of America Merrill Lynch, said the plan was at the high end of market expectations.

“We’ve seen over the last few years you have to trust in Mario,” Laurence Fink, chief executive officer of BlackRock Inc., said in Davos. “The market should never, as we have seen now, the market should not doubt Mario.”

The ECB’s shift exacerbates an emerging global split. While the Fed is considering when to tighten credit, central banks in Denmark, Turkey, India, Canada and Peru all announced surprise rate cuts in the past week. The Swiss National Bank shocked investors by dropping a cap on the franc.

The ECB’s Governing Council agreed to a faster pace of purchases than Draghi had proposed when they first gathered on Wednesday. While the size of the plan was the same as one cited by euro-zone central bank officials yesterday, buying was accelerated by 10 billion euros a month for completion three months sooner.

Jack Ewing said in a piece for The New York Times that any additional moves would be up to individual countries:

With the European Central Bank now stretched to the limits of its powers, any further economic stimulus steps would need to be by national leaders, if they deem it necessary to improve growth, reduce the bloc’s 11.5 percent unemployment rate and prevent a catastrophic decline of prices known as deflation.

Such steps would involve the sort of extensive government spending that many countries, including Germany, have been reluctant to pursue, hewing, instead, to a philosophy of budget discipline that has acquired the shorthand label of austerity. The German chancellor, Angela Merkel, on Thursday warned her peers not to waste the breathing space given them by the central bank.

“We should not become diverted from the fact that we as politicians need to put a framework for recovery in place,” Ms. Merkel said at the World Economic Forum in Davos, Switzerland, minutes before the European Central Bank announced its decision in Frankfurt.

In essence, the central bank would create new euros and use the money to buy assets on the market, largely government debt. The increased demand from the European Central Bank should raise bond prices and push down yields — reducing the borrowing costs of eurozone governments. If the tactic works, it would ripple through financial markets, pulling down the interest rates on other types of debt, like business loans. The increased borrowing that results would stimulate demand and help drive inflation.

The ECB has a tough task ahead and not a lot to work with given the state of the various economies in the Eurozone. While it is offering cover for many countries, it will be interesting to see if the heavy spending alienates some members. But something must be done to provide some stimulus since Europe is pulling down the rest of the world’s growth.