Today sees the latest policy meeting of the European Central Bank or ECB. Please do not adjust your laptops,PCs,tablets and smart phones as it is Wednesday and not Thursday! ECB President Mario Draghi has a career as an international jet setter to maintain and is off to the IMF Spring Meeting tomorrow. However it gives us a timely opportunity to consider what the economic impacts of QE or Quantitative Easing actually are.
So let us first examine what the ECB has done so far. As of April 10th it has purchased some 67.15 billion Euros of Covered Bonds, some 61.68 billion Euros of sovereign debt and some 5.26 billion Euros of Asset Backed Securities. What do we learn from this? Well firstly the earliest and so far largest amount goes into supporting the banks and the mortgage market in a familiar theme for central banking in the credit crunch era as they are invariably to be found protecting the “precious”. Let us examine the definition of them from the Financial Times.
A bond backed by assets such as mortgage loans (covered mortgage bond). Covered bonds are backed by pools of mortgages that remain on the issuer’s balance sheet, as opposed to mortgage-backed securities such as collateralised mortgage obligations (CMOs), where the assets are taken off the balance sheet.
So help for an instrument on a bank’s balance sheet. Is there no end to supporting bank profits?! At this point one feels the need to point out that this is the third effort in this area which apart from making life awkward for headline writers who claimed the ECB was starting QE for the first time during this phase shows how it has always rushed to the banking sectors aid. Parts one and two still amount to 37.32 billion. According current ECB QE amounts to either 134.09 billion Euros or more accurately 171.41 billion Euros. It also poses a problem because if the first two Covered Bonds purchasing programs were such a success why did they stop and restart and stop and restart? Also for those who like a little humour here is a past ECB President Jean-Claude Trichet on this subject from 2009.
the usefulness of more conservative asset classes such as covered bonds, which have proved to be safe assets over a long time, is obvious……when the covered bonds market virtually shut down.
Yes so conservative and safe that the market shut down and needed ECB support. Oh hang on! Also there is this gem about housing markets.
Second, the housing market. In the United States it is at the epicentre of the crisis. This is not true for the euro area.
Also Mario Draghi made a big deal about purchases of Asset Backed Securities whereas the purchases since they began in late November have been relatively measly especially if we use what might be called QE inflated mathematics.
A Sovereign Bond Bubble
This is one clear impact of the QE era as we see bond markets surge to new and indeed until recent times completely unexpected price highs and yield lows. It was only on Friday that I was discussing a slipstream effect of ECB policy which is the fact that Switzerland sold ten-year bonds last week with investors in effect paying it interest! Yesterday saw a more direct effect as investors in effect paid the government of the Netherlands (-0.094% per annum) for the right to buy its five-year bonds which was a first for the Dutch. The list of countries with negative bond yields is growing and Goldman Sachs have estimated that they now apply to some 1.8 billion Euros of sovereign debt. The ten-year yield of Germany has dropped to 0.13% this week posing the question whether it too will slip below zero. We have two issues here. Firstly the point of a bond is that it PAYS interest so what sort of twilight zone are we entering when investors are willing to pay themselves rather than receive it? Also we have the issue raised earlier by JC Trichet of a “safe asset” does that merely mean front-running a central bank?
The Economic Effects
We have falling mortgage rates as shown here from Dutch News.
Last year the interest on a 10-year mortgage fell a full procentage point and a further 0.45% in the first three months of this year. The interest on a 20-year mortgage also fell a full procentage point and a further 0.7% in the first quarter, Hypotheekshop said.
Not all of this is due to QE but some now is. Also sovereign governments can borrow more cheaply and thereby spend more. How good that turns out to be for economies depends what they spend it on as there is a clear moral hazard here! But countries where default is looming on the horizon like Italy and Portugal are seeing large gains.
Bad and Ugly
We come back to side-effects one of which was highlighted yesterday by the central bank of the Netherlands.
A prolonged period of low interest rates affects the resilience of Dutch financial institutions, insurance companies and pension funds in particular, and banks to a lesser degree. Its impact on life insurers may ultimately jeopardise financial stability, as they have limited recovery options and considerable interdependencies with other financial institutions.
What about any business which relies on long-term interest-rates such as many types of savings or annuities? They have disappeared into the ether surely? What about the countries such as Germany and Spain who were showing solid economic growth anyway? They did not need a sovereign bond boost as we fear too much petrol in the carburetor.
We are back to Yazz as the only way for these is up in the QE era. Last week saw the Nikkei 225 touch 20,000 for the first time in a very long time compared to the circa 9000 when Abenomics began. The Eurofirst 300 equity index was below 1300 when the rumours of a sovereign QE program was announced really built up last December and is now at 1651 for around a 27% surge. The problem here is what economic gain or “wealth effects” take place? They are notoriously hard to pin down as we wonder if the value of bank assets are simply being driven higher again. Deutsche Bank for example was flirting with a 24 Euro share price back in December compared with 33 Euros now.
This is perhaps the clearest possible win for some of the Euro area. After all countries such as Greece and Portugal for example plainly need a lower exchange-rate to compete economically. Of course we do know that QE is part of a set of ECB policies which are intended to push the value of the Euro lower what we do not know is how much of an impact it has had?! We can merely say that since the QE expansion rumours really built up in mid December last the trade-weighted Euro has fallen by around 10%. This is the clearest economic boost of the lot although sadly for it the situation was marred by it raising the price of oil in Euro terms and thereby offsetting some of its fall.
Back in the days when QE was a twinkle in a central bankers eye then it was assumed to be something which raised economic growth via raising inflation. Of course in the central banking version of Alice In Wonderland that scenario still exists! Meanwhile we find ourselves observing a raft of effects operating in various directions. Firstly the inflation created initially is to be found in asset markets. This is extremely convenient as of course official inflation measures invariably ignore these! Indeed the Euro standard inflation measure HICP (Unhelpfully called CPI in the UK) ignores owner occupied housing costs entirely. Thus inflation becomes growth and wealth increases through the central banking looking-glass. If we move forwards in time we are likely to see ordinary consumer inflation pushed higher by the lower exchange-rate. This may prove to be a more serious problem if we note that the oil price seems to have at least stabilised and may be edging higher. If we look for economic growth then we see that a lower exchange-rate may help and that lower mortgage-rates (for some at least) may help. Governments may indulge in more deficit financing. The catch is of course is that we are describing roads which got us into our current mess as Talking Heads remind us.
We’re on a road to nowhere Come on inside Takin’ that ride to nowhere We’ll take that ride
A literal GDP boost
It would appear that a Dutch central banker decided that more practical measures were required to boost the new Gross Domestic Product growth rates.
A worker for the Dutch central bank, who worked in the trust regulation department, has been sacked for working as an S&M prostitute for years,,,,,Her roles included that of an SS commander
Rather ironically considering many people’s views on bankers she was sacked for lacking integrity.