Mario Draghi is such an old tease.
The European Central Bank president has hinted for months that he is poised to hit the quantitative-easing button in a last-ditch effort to reverse falling inflation and fire up the stagnant economy. On Nov. 21, the teasing seemed over. Super Mario would – finally – come to the rescue, declaring in a speech that the ECB would "do what we must to raise inflation and inflation expectations as soon as possible."
Sovereign bond yields duly tumbled as investors took the view that quantitative easing (QE) would be unveiled at the ECB's next policy meeting, on Dec. 4 in Frankfurt. Spain saw its 10-year yields fall below 2 per cent, the level that far-healthier Britain and Canada pay for their debt, while the bonds of Italy, France and a few other countries hit record lows.
Then on Wednesday, at a Financial Times banking conference in London, ECB vice-president Vitor Constancio threw a reality check into the market. QE might well be coming, he confirmed. But if it does come, it won't be in December – early 2015 is more likely.
The holdup? The ECB is already buying covered bonds and just recently started to buy asset-backed securities from banks. Apparently Draghi & Co. wants to see if those purchases do the trick before cranking open the QE spigot.
"We have, of course, to closely monitor if the pace of [the purchases'] evolution is in line with expectations," he said. "In particular, during the first quarter of next year, we will be able gauge better if that is the case … If not, we will have to consider buying other assets, including sovereign bonds in the secondary market, the bulkier and more liquid market of securities available."
So what will Mr. Draghi do on Dec. 4?
Having assured the market that the ECB must raise inflation "as soon as possible," he has put himself under enormous pressure to take some action, if not launching outright QE itself. Options at the Thursday meeting include announcing the purchase of corporate bonds or setting a figure for the expansion of the ECB's balance sheet. The ECB has said it wants the balance sheet to return to its March, 2012, level – about €3-trillion (about $4.3-trillion) – from the current €2-trillion. But the figure was presented more as an expectation, not a firm target.
It is well known that Mr. Draghi would prefer a firm target, but on this issue and others related to the launch of QE, he has his opponents. Which raises the question: Even if Mr. Draghi himself wants QE, will he get outmanoeuvred by the forces conspiring against him? Those forces can be summed up in one word: Germany.
Germany is, at best, lukewarm on deploying U.S-style QE, an epic money-printing exercise that saw the U.S. Federal Reserve buy some $3.5-trillion (about $4-trillion Canadian) of treasuries, the debt of government-sponsored mortgage agencies and mortgage-backed securities. The goal was to prop up the financial sector and, later, fight low inflation. While the program seems to have met some success, – the United States, unlike the euro zone, is no longer in danger of slipping back into recession – it was not without its critics. They argued, among other things, that QE distorted asset prices and made the wealthy even wealthier, since the rich own most of the assets whose values swelled under QE.
Germany has similar concerns, and others, beginning with the legality of sovereign bond purchases that would probably dominate a European version of QE. Germany's constitutional court punted the ECB's outright monetary transactions (OMT) program to the European Court of Justice, where it is being debated. OMT, announced in 2012, has not been used, but would see the ECB buy the bonds of any euro zone country having trouble financing itself. Germany has argued that financing governments is not within the ECB's mandate and may take a similar view with QE. , even though any purchases would be made in the secondary market.
Jens Weidmann, president of the Bundesbank (the German central bank) and member of the ECB's governing council, is an opponent of QE, once calling it a "dangerous path." He has an ally in Yves Mersch, who is a member of the ECB's governing council and executive board.
Other than worrying about the legality, or lack thereof, of QE, they fear that QE is synonymous with moral hazard. If QE inflates asset values and pushes down interest rates, as they are designed to do, wouldn't that just remove the economic reform incentive in struggling countries? It's a good argument. Indeed, since Mr. Draghi launched the OMT program two years ago, bond yields have plummeted, removing the "crisis" from the euro zone crisis. Since then, the reform efforts of France and Italy, the euro zone's main problem areas, have stalled.
Another problem with QE is that Germany doesn't really need it, but could not avoid it since any sovereign bond purchases probably would be based on the size of a country's contribution to euro zone gross domestic product. Since Germany is the biggest economy, its bonds would be bought in the greatest quantities. While the Germany economy is barely growing, you could argue it is the state in least need of more stimulus. On Thursday, its jobless rate was reported at a record low of 6.6 per cent.
Finally, the German contingent at the ECB doesn't fear falling inflation as much as Mr. Draghi. Mr. Weidmann has urged calm, saying recently that "a problematic wage-price spiral is still a remote prospect."
Mr. Weidmann may be right. But if he's wrong, Mr. Draghi should be able to overcome the German resistance. The only thing worse than QE is a new recession or revival-killing deflation. Even Messrs. Weidmann and Mersch might agree with that. Until the euro zone is solidly back on a growth path, Mr. Draghi will keep his QE teasing alive.