ECB’s QE: Don’t expect any wonders!

ECB’s QE: Don’t expect any wonders!17.05.2015

Post-2008, the recovery in the 19-member euro zone has been anemic, to say the least. In a latest, the bloc registered an annual 0.2% decline in prices, which is very symbolic considering that this is the first instance since 2009 and yet again stokes fears that the economy may enter a prolonged deflationary period, like Japan, which has failed to see any real inflation in more than two decades. While the US has shown a modest recovery since the recession, most of the European nations are still in the clutches of deflationary pressures. As a result, interest rates have been dragged down to historically low levels, to spur consumer spending and stimulating the investment cycle. With interest rates failing as a tool of economic recovery, the European Central Bank (ECB) had recently introduced an asset purchase program of €60bn per month, which will start in March 2015 and continue until at least September 2016. While the QE program came out bigger than many expected (most of the expectations averaged €500bn), the big question remains: Would the €1140bn (60*19) stimulus package be enough to pull the dismal euro zone economy out of the abyss?

Is this QE set to fail?

According to December press reports, the ECB had run studies which firmly suggested that an asset purchase program of €1000bn would push up prices by only 0.2-0.8% after two years. This clearly strengthens the fact that the current QE is too little if the inflation expectations were to match the targeted 2% in the medium term. Economists and financial markets across the globe are now beginning to predict an expanded QE to the tune of €2-3tn post-September 2016.

Also, various economies that have rolled out QE, such as China, Japan, and US have failed to report a convincing upturn in the economic landscape. Their measures of debasing their respective currencies in order to boost inflationary expectations and initiate consumer spending have been rendered ineffective for the lack of any significant structural reforms.

Another global phenomenon that is forcing the price levels in red is the crash in commodity prices. Many commodities such as crude oil, natural gas, copper, and others are witnessing a continuous decline owing to the supply glut and lack of any significant demand across the global economy. Sustenance of depressingly low levels in the essential commodities reflects that the world economy is in a much terrible shape than earlier thought and considerably lowers the growth outlook. The IMF also sliced its global growth forecast to 3.5%, from an earlier expectation of 3.8% (projected in October).



Euro: How low will you go?

The Euro crashed against the dollar as soon as the official announcement of ECB’s QE came in. Printing money to inject liquidity into the monetary system devalues the currency as the supply exceeds the demand. And assuming that the introduced stimulus may eventually give way to a bigger program, the chances of which are incredibly high in the present scenario, the euro may not see its peak levels of above-1.50 for a considerable long time. In addition to the domestic troubles, the euro faces significant threat from a rising dollar, which has been marching up against a significant basket of currencies after the US Fed ended its bond-buying plan and is contemplating hiking the interest rates during 2015. Considering that the only developed economy that is showing any sign of economic growth is the US, investors are flocking back to the greenback.   

Apart from the fundamental factors mentioned above, let’s take a look at the technical aspects of the EUR-USD relationship.


The weekly price chart of EUR-USD clearly presents a miserable picture for the Euro. The chart spans the period from 2000 till date and spells out sub-1.000 level for thecurrency. Prima facie, the pair has broken below the crucial support zone of 1.18-1.20, which was not even breached during the 2008-recession or the European sovereign debt crises. Technically, the follow price pattern was that of a descending triangle, which is a bearish pattern and sets the target at 0.900 versus the dollar.

 Will QE only create asset bubbles?

The answer to this question is perhaps one of the most anticipated ones. Acknowledging that primary investment classes such as equities and real estate are defying gravity, it becomes even more imperative to inculcate financial risks that may arise following the massive fund injection. The central banks have been widely criticized for expanding their balance sheets beyond respectable proportions and instead of a resurgent global economy, QE’s have only fueled stock market rallies. A similar action followed in European stocks which scaled new heights post the announcement. With financial markets now factoring more stimuli from ECB until its inflation target of 2% is met, the stock markets may continue to fly higher without heeding lack of growth.

However, on a positive note, the export sector may benefit greatly from the depreciating currency. A devalued currency makes the export-oriented industrieshighly attractive as the payments inflow is in terms of a stronger foreign currency, mainly the dollar.

The imports will get painfully expensive and in the absence of major structural and fundamental reforms, many small and medium industries may face the risks of bankruptcy, which will only add to the increasing unemployment figures in the highly rigid labor markets.

Listen to the Super Mario

The ECB president Mario Draghi hopes that the new stimulus “should strengthen demand, increase capacity utilization and support money and credit growth.” However, he did not desistfrom affirming that the largess alone wasn’t enough to bring back prosperity in one of the most troubled spots of the global economy. He has clearly transferred the onus of reviving money supply on to the national banks which are mired in debt.

He also called upon the member nations to bring about strict reforms to resuscitate the flailing economy. “What monetary policy can do is create the basis for growth,” he said. “But for growth to pick up, you need investment; for investment, you need confidence; and for confidence, you need structural reform.”

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