It is now nearly a year since Mario Draghi and the European Central Bank fired the starting gun on a large-scale move into Quantitative Easing. After its Christmas break it has this week resumed its 60 billion Euro’s per month of bond purchases as it chomps away on Euro area debt like a Pac-Man. In the meantime the period for which it will exist has been extended from September this year to March 2017. So it is time for us to take a look back over this period and see what has been achieved. For those wondering why I defined it as the beginning of large-scale QE it is because the purchases of Greek,Irish and Portuguese debt fitted the bill on a smaller scale as did the two efforts at covered bond purchases. As an aside it is an irony of sorts to see complaints that Greece is not part of the new program as of course there is so little left to buy as around 80% of it is in official hands.
The position here is one that this morning has received some good news. The latest Purchasing Managers Index survey is optimistic looking forwards.
The eurozone economy ended 2015 on a positive note, with the rate of expansion in output rising to a four-month high and growth over the final quarter as a whole the quickest in four-and-a-half years. The expansion was broad-based, with December seeing activity rise across Germany, France, Italy, Spain and Ireland.
So you can see that the survey was bullish for a good 4th quarter which is in stark comparison to the United States where expectations for the same time period have fallen. It is also nice for once to see Italy have some genuine hopes of an improvement. But as the results of the survey progress some of the optimism disappears.
However, despite the improvement, the survey data signal a modest 0.4% increase in GDP in the fourth quarter, which would mean the eurozone grew 1.5% in 2015.
If correct this poses something of a problem for the ECB and let me illustrate this with quarterly economic growth since the beginning of 2014. It goes 0.2%,0.1%,0.3%,0.4%,0.5%,0.4% and 0.3%. The uplift began some 6 months before QE began and you could easily argue that it has made little or no difference so far. That would be not so dissimilar to the UK experience, as for all the hype about Bank of England QE the boost to the housing market via the Funding for Lending Scheme would never have happened if QE was working as advertised.
The crude oil effect
If we look at the improvement in the Euro area economic growth trajectory then it fits much more neatly with the fall or if you prefer plummet in the price of crude oil and other commodities which has taken place. Brent Crude Oil nearly touched US $116 in late June 2014 but was below US $50 at the year-end. I have argued before that this boosts consumption via such factors as higher real wages as it cuts consumer inflation so let us take a look.
In October 2014 compared with September 2014, the seasonally adjusted volume of retail trade rose by 0.4% in the euro area…….In October 2015 compared with October 2014 the retail sales index increased by 2.5% in the euro area
Whilst correlation does not prove causation the improvement in retail sales and consumption in the Euro area fits a lower oil price pretty well as much happens before QE was even a twinkle in Mario Draghi’s eye. Also I note that if we look back to January 2015 Mario Draghi agreed with me.
Looking ahead, recent declines in oil prices have strengthened the basis for the economic recovery to gain momentum. Lower oil prices should support households’ real disposable income and corporate profitability.
The Euro exchange-rate
This is awkward because if we look back we see that after the QE announcement the effective or trade-weighted Euro exchange-rate fell to 92.2 late last January and it is now ahem, 92.2! Okay so we return to my theory that exchange-rates fall in anticipation of QE and we see that the Euro effective exchange-rate was falling anyway in 2014 but from mid-December fell from a convenient 100 to 92.2.
There are issues with this as of course the exchange-rate is falling in anticipation of monetary easing and cannot have known – in spite of the hedge fund briefings – exactly what was going to happen. For example the ECB could have dipped its foot rather than its toe into the world of negative interest-rates.
Yesterday provided yet another disappointment for the ECB as the consumer inflation data was released.
Euro area annual inflation is expected to be 0.2% in December 2015, stable compared to November 2015,
This compares to the objective stated by Peter Praet of the Executive Board only this morning.
You may label that ECB policy a success if inflation, the rise in the cost of living, stays below, but close to, 2% over the medium term. That is our mandate.
Consequently Peter thinks this about the state of play.
I admit that our policy has not yet been successful enough: inflation rates in Europe have been at the very low level of almost 0% for quite some time now.
Accordingly he hints at “More,More,More”
That is why we are continuing to take the necessary measures to drive inflation up to 2% over the medium term.
Here is where I completely depart from the ECB view and indeed much of the analysis you will find in the media and elsewhere. I welcome the “failure” of the ECB in this area as lower consumer inflation driven by the falls in the price of commodities and oil has pushed real wages higher in the Euro area. This has boosted consumption as I highlighted earlier by looking at retail sales data. Once you think of it like that the ECB has in fact acted against the interests of ordinary consumers and workers by trying to drive inflation higher and make things more expensive. Accordingly its failure in this regard has boosted the economy in 2015 and looks likely to do so further in early 2016.
If we move to the exchange-rate impact which will have been the main driver here we see that it will have had a very mixed and potentially adverse overall impact. In simple terms a lower effective exchange rate is expected to generate more net exports although in the credit crunch era less so than in the past. But against that we have the way that it has raised material costs (or more specifically they have fallen by less than otherwise). Also we have the way that it has offset the beneficial falls in consumer inflation and rise in real wages.
This morning Peter Praet has tried to muddy the waters on the issue of QE.
If the ECB had not taken the measures that it did, we would be in a depression; I’m convinced of that. And a depression would be much worse than what we are experiencing today and worse than what we went through over the past decade.
He is deliberately obfuscating by combining all the ECB monetary easing measures rather than just discussing the QE ” €1.5 trillion (i.e. €1,500,000,000,000),” . Although I can agree with him on this.
The ECB’s policy undoubtedly has unintended consequences.
My view is that the “unintended” here has been the beneficial oil price fall which completely changed changed late 2014 and 2015 and will run into early 2016. But Peter’s QE policies have offset that to some extent in a failure which has attempted to undermine an economic success.
Another way of looking at this is we move from the “deflation” mantra of these times -although they usually fail to understand they mean disinflation – is that there is a clear sign of inflation. Today we find it in the case of where deploying €1,500,000,000,000 has so little effect. We have moved from billions to trillions as we wonder whether quadrillions will be along soon?
We also have an addition to my financial lexicon for these times.
In some countries, there is a risk that real estate prices or some equity and other financial markets are increasing in a way that is too rapid or artificial. We are keeping a close watch on that.
Close watch means do nothing.
Oh and I did not realise that Peter and the ECB have imported tactics from England’s Rugby World Cup campaign.
There is no plan B, there is only one plan.