Calls for QE Pose Headache for ECB
For the ECB, QE just won't RIP.
If the European Central Bank hoped its raft of actions in June would quell the debate around quantitative easing, it must be disappointed. The International Monetary Fund has renewed its call for the ECB to be ready to undertake asset purchases if needed. This underlines a looming challenge for the ECB, even if the IMF's faith in the power of QE looks misplaced.
The IMF welcomed the ECB's actions to cut rates, provide liquidity and boost corporate lending. But it argued that if inflation remained low, the ECB should be prepared to buy government bonds on a large scale, increasing the size of its balance sheet. "This would boost confidence, improve corporate and household balance sheets, and stimulate bank lending," the IMF said.
That represents the orthodox line on QE, which makes it worth questioning.
The main channel for bolstering confidence is through boosting asset prices. The first dose of bond purchases by the Federal Reserve clearly provided a vital lift to confidence in this way.
But euro-zone bond and stock prices already have risen sharply since ECB President Mario Draghi pledged in 2012 to do "whatever it takes" to save the euro. There are concerns about the effects of QE on financial stability.
Second, while higher asset prices might help lenders feel more confident and reduce borrowing costs, it isn't clear they would directly feed through to an improvement in corporate and household balance sheets. The IMF itself notes that sovereign- and corporate-bond yields are at historical lows "in many countries." Many Europeans don't have direct exposure to financial markets; there might not be a particular effect on households at all.
Finally, it isn't clear that QE would necessarily boost bank lending. This has been a constant complaint in the U.K. and U.S. This may reflect both credit supply and demand problems: Banks are being forced by regulators to become safer; consumers and companies could be reluctant to borrow. Both are likely in the euro zone, where the process of cleaning up bank balance sheets has been slower than elsewhere.
But the IMF's recommendation still points to a problem for the ECB. The debate about QE seems unlikely to go away. The central bank, therefore, needs to keep QE on the table as a possibility, without making the market believe that it is certain. A certain level of ambiguity is required. The current tactic, used by executive board member Benoît Coeuré in his response to the IMF's call Friday, is to say QE is possible but unnecessary now.
That may work for some time. But if the clamor for QE becomes louder, it may not satisfy investors who are aware the ECB faces practical problems in buying government bonds, given the fragmented nature of euro-zone markets and the political stink it might cause. The IMF's promotion of QE only complicates the ECB's balancing act.