Wednesday, 23 January 2019

Easy does it

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  • Easy does it

The market appears broadly to have welcomed the introduction of QE by the ECB but there is a view, shared by the bank, that more reforms are needed. Even so, it will be a while until any definitive assessment can be made.

“Before, you are wise; after, you are wise. In between you are otherwise.” The author David Zindell’s take on our struggle to make sense of the world without the application of happy foresight or smug hindsight applies to almost everything we do, from tidying a room to reforming an entire economy.

Take the European Central Bank’s attempts to revive the throttled eurozone, by buying €60bn (US$67bn) worth of public and private-sector assets a month until September 2016 – and possibly far longer. Hanging over the entire stimulus programme, unveiled in January by ECB president Mario Draghi, are a trio of imponderables: has it worked; is it working; and will it continue to work?

So far at least, all signs augur well. In May, the European Commission raised its forecast for the 19-nation eurozone block, projecting growth of 1.5% in 2015 (up from 1.3% in February) and 1.9% in 2016. The same data tip Germany, the region’s economic super-turbine, to grow by 1.9% in 2015 and 2% in 2016, with fast-reviving Spain seeing output expand by 2.8% and 2.6% respectively over the same period.

Inflation offered further cause for cheer, with prices declining by just 0.1% year-on-year in March, against a fall of 0.3% the previous month, pushing the region back towards inflation territory. Pierre Moscovici, Europe’s Commissioner for Economic and Financial Affairs, talked up the positive impact of stimulus, praising its ability to create the “brightest” economic conditions in years.

Yet to what extent does the region’s renewed hope and sense of economic vigour really stem from quantitative easing? Is stimulus, by initially devaluing the single currency and helping to channel cheaper funding to regional issuers (as well as easing the minds of fretful bond investors), primarily responsible for this renewed optimism? Or did Draghi and the ECB simply get lucky, timing QE to benefit from cheaper oil just as the eurozone was turning the corner?

Design or accident

Most experts agree that stimulus, whether by design or by happy accident, has ultimately been a boon to the region’s prospects. “Is QE working? The obvious answer is ‘yes’,” said David Owen, chief European economist at Jefferies. “We are now in an environment of improving financing conditions.”

Said William de Vijlder group chief economist BNP Paribas: “Without QE, the euro would be at a higher level. What QE does is to take out the tail risk and give us a big confidence boost.”

So far so good. But will it remain effective? True, stimulus has so far “worked quite well”, said Frederik Ducrozet, senior eurozone economist at Credit Agricole. Rates have fallen, fostering looser monetary conditions and helping to push up European stocks. In the three months after Draghi unveiled QE, the STOXX Europe 600 index gained 12%.

“QE is probably also having an impact on the timing of the rate decision by the Fed, although they would not say that explicitly”

Yet it is difficult to predict QE’s long-term impact, in part because the data underlining its impact are frustratingly conflicting and changeable. Take the single currency. In the seven weeks after QE’s launch on January 22, the euro shed nearly 10% of its value against the US dollar. Eurozone governments cheered; ECB officials breathed a sigh of relief.

The success was met with jubilation in Brussels and Frankfurt, but concern in Washington.

“The US Federal Reserve is most likely uncomfortable with the US dollar moving toward parity with the euro, especially as US macro has disappointed so far this year,” said Marcus Svedberg, chief economist at emerging market investment manager East Capital.

“QE is probably also having an impact on the timing of the rate decision by the Fed, although they would not say that explicitly.”

Not all has been plain sailing. After ceding a generous chunk of value to the US dollar, the euro then surprised by reversing a large slice of its losses, following the publication of weaker than expected US jobs data, gaining 7.2% in the three weeks from April 13. As May wore on, the turbulence continued, with the dollar regaining some of its strength as traders began to bet more urgently on the first rise in US interest rates since 2006.

And what of growth? Did QE help to inject growth in the region, or merely piggyback on prevailing positive factors? Rising economic output and consumption were already in evidence in Germany and Spain last year, two countries that benefited from painful and protracted rounds of labour reforms in, respectively, the mid-2000s and the post-crisis era.

Economists believe the eurozone’s turnaround started in earnest a year ago, spurred on by the impact of lower oil prices, which boosted consumption, and by less visible but confidence-inducing factors such as stress tests designed to gauge European lenders’ ability to react to future crises.

Andrew Rees, a London-based economist at Macquarie, agreed that QE had driven up asset prices and countered the threat of deflation. But he said: “Whether it has [had] much effect on the real economy in boosting bank lending, investment and economic growth is less clear. And its impact here is likely to be modest compared with what happens to the oil price, world demand, and geopolitical events such as in the Ukraine.”

More reform needed

Anatoli Annenkov, senior European economist at Societe Generale, goes a step further. A long-time sceptic of the benefits of European stimulus, he believes that in order to prove a success, QE must be accompanied by more reform, a point of view shared by ECB president Draghi.

“Whether it [QE] has had much effect on the real economy in boosting bank lending, investment and economic growth is less clear”

“We share the traditional central bank view that throwing money at a problem won’t create more growth,” he said.

Annenkov admitted that the region’s economy had improved far quicker than he had expected.

“But things were improving even before QE was launched,” he said. “The key change was the oil price shock and, [along] with that, low inflation as well, creating a double boost to disposable income.”

QE helped to improve “an already brightening economy”. But there had been “way too much excitement about stimulus, thanks to a weaker euro and higher growth data”, he said.

The latter point certainly appears to be true. A euphoric market, said Macquarie’s Rees, was “already talking about whether QE will have an early exit, with most forecasters revising up their view of economic prospects in the eurozone, and inflation edging towards positive territory”.

Almost certainly, the opposite will prove to be the case. Regional prospects had been buoyed by lower energy prices, rising consumption, and a weaker euro. Yet by September 2016, a few of these positive factors may well have fallen away.

“Against consensus, 2016 could see lower growth than this year,” said Rees.

Others are even more downbeat about the region’s medium-term prospects. Societe Generale tips eurozone growth to peak at 1.6% in 2016 before declining.

“We believe growth may peak next year in the eurozone, after which we will return to a lower growth and lower inflation environment in 2017,” said Annenkov. “We see QE continuing for another nine months after September 2016.”

And what of the debt markets? So far, it appears that QE has exerted both seen and unforeseen effects on the bond issuance programmes of sovereigns and corporates. Some see little evidence of before-and-after change.

To others, this aspect of stimulus – its ability to provide impetus to dawdling issuers – has been an unqualified success, creating better euro financing conditions, supporting the market, and pushing rates lower.

But it’s hard to divine the long-term impact of QE, in large part because we are now stuck in that fallow middle ground where predictions, to paraphrase the author Zindell’s thinking, are bunk. It was impossible to predict the impact of QE before it started (many tried, few succeeded). Likewise, the true and lasting effects of stimulus have yet to be seen.

For now, it’s fair to say that European-style QE has had at least a narrow impact on growth and eurozone financing conditions, and a broad impact on confidence and impetus. Stimulus has clearly pushed regional sovereigns and corporates to extend debt maturities, just as it has pushed investors, desperate for an inch more yield in the face of crushingly low rates, to embrace riskier assets.

But has it succeeded? We will probably have to wait until next autumn to answer that question, and perhaps a little longer.

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