This past week, after two years of “jawboning the world to death,” the European Central Bank (ECB) launched their version of quantitative easing or QE. Interactive Investor’s Lance Roberts commenting of the subject questions: Will Eurozone QE work?
QE Program
The size of QE program is €60 billion ($67.5b) per month, €1,140 billion in total. The main measure is an expandable asset purchase program that includes European agencies and sovereign and complement the current programs [covered bond and ABS(asset-backed security) purchase programs]. Those new programs will start in March 2015 and run until end September 2016 or until the inflation outlook converges to 2.0% medium-term, which means that it could be bigger.
The ECB will purchase €1,140 billion from March 15 to September 2016. Today, the pace of covered bond and ABS purchases is close to €13 billion per month, so additional purchases represent €47 billion per month. (Note: The Federal Reserve was doing $85 billion per month during QE3).
The ECB stated that “purchases of securities of European institutions will be 12% of the additional asset purchases”. A quick rule of thumb suggests €230 billion in ABS and covered bonds, €110 billion in European agencies and €800 billion of sovereign bonds.
The ECB also decided to cut the spread on the TLTRO (targeted longer-term refinancing operations) rate, which would now be equal to the refinancing rate (0.05% instead of 0.15%).
Criteria
We know that the new programs are running until September-2016 at least and that purchased bonds will be held up to maturity. Obviously, purchases will be made on the secondary market for European issues and government bonds.
In terms of rating, it is likely that the conditions will be the same as for the ABSPP (Asset-Backed Securities Purchase Program) and CBPP3 (Central Bank Purchase Program). First, the ECB will purchase investment grade bonds.
Secondly, for Greece and Cyprus (which are not investment grade), the condition would be that those countries “have an ongoing program with the EU/IMF”.
Can the ECB buy at negative yield? Yes, President of ECB Mario Draghi said during the press conference.
Which maturity? Details will have to be specified in March but Draghi suggested that maturities could be of 2-30 years.
Risk Sharing
The main piece of information in the ECB communique is here:
“With regard to the sharing of hypothetical losses, the Governing Council decided that purchases of securities of European institutions (which will be 12% of the additional asset purchases, and which will be purchased by National Central Banks) will be subject to loss sharing. The rest of the NCBs’ additional asset purchases will not be subject to loss sharing. The ECB will hold 8% of the additional asset purchases. This implies that 20% of the additional asset purchases will be subject to a regime of risk sharing”.
So the ECB indicates that the degree of risk-sharing is 20%, which seems a good compromise. However, regarding government bonds, the degree of risk sharing seems symbolic. To put it simply, the ECB will purchase €70 billion on a risk sharing basis while the NCB will purchase the remaining €730 billion.
Will It Work?
Of course, the real question that needs to be answered is whether or not it will actually lead to higher levels of inflation, employment, and economic growth?
With unemployment remaining extremely elevated, inflationary pressures plunging, and economic growth waning, you can see why the ECB has become desperate to “do something” to try and reverse the tide. However, while it is certainly hoped that the ECB can spark inflation and better economic growth with the current QE program, there is little evidence that it actually worked in either Japan or the US.
