Why I welcome the fact that ECB QE has been a failure in its main objective

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.

Economic activity

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.

Inflation

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.

Comment

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.

 

 

 

 

 

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11 thoughts on “Why I welcome the fact that ECB QE has been a failure in its main objective

  1. Hello Shaun ,

    I actually disagree with you . I ‘d posit its been a success , not in its headline reason , but in it real reason

    And Greek debt has been put on the back burner – or can kicked 😉

    As for the price of oil and other commodties , if they had not fallen , would the ECB still say it was a success ? too right they would !!

    And again here we have someone who seems to want inflation! the bogey man of the last century ( pre 2000) is apparently our “friend”

    “Who’s Zoomin’ Who” by Aretha Franklin……..

    Forbin

    PS : ” … 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. ”

    Are their brains years behind everyone elses?

    Can I get job there as they seem to be able mutter utter nonsense and get paid vast sums of wonga for it …….

    • Hi Forbin

      Those jobs are kept in a tightly held circle. The last thing they’d want is someone telling the truth. As to your point I agree that there is yet another element of can kicking which is a type of each-way bet. If the economy improves then claim it is due to QE and if it does not say you are doing your best via QE. The one area where I have a lot of sympathy for the ECB is that the political class in Europe has left it to do all the economic lifting when they should have done their bit.

      Seen oil ? Yet another bad day for it and good for us. Mind you at these prices even a near 6% move is not that large in absolute terms….

  2. Hi Shaun

    It is interesting that Peter Praet says that the actions of the ECB have prevented a depression and that what we would have had would be much more severe in the absence of the policy measures.

    The obvious question to ask is: why would we have been at risk of a depression? The reason why we have recessions and depressions is to clear excesses and to return matters to trend (in simple terms). The fact that you admit the possibility of a depression shows that you admit that there were excesses and what he is saying is little more than what the ECB has done is to paper over the cracks and, in effect, prevent the very process which is necessary to resolve the problems.

    In these terms QE has failed because it has prevented the process of getting rid of the excesses.

    • I agree that a certain amount of catharsis is necessary to maintain a healthy economy. Certainly in the private economy this is usually the case and a flabby ineffective company will soon go to the wall. What a pity the banks were too big to fail!

  3. Hi Shaun,
    Bob J’s comment reminded me of a conversation with my neighbour a few months ago.
    He asked ” What was wrong with boom and bust?” He maintained that trying to prevent a bust (be it economies, banks, households) only stored up more trouble for the future – trouble which TPTB have no experience in handling.

    Should I tell him he could be right?

  4. ‘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.’

    The reality in terms of real earnings and debt is that we are in a depression.If the ECB(and other CB’s) had not taken the actions they did,then most likely the worst of the recession would be over.

    Quite why these people think that running 5%+ fiscal deficits and achieving 2% GDP growth(and said growth should be treated with a healthy dose of scepticism first) is a solution to anything,I will never,ever know.

    You rightly point out Shaun
    ‘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.’ You can imagine them if they ever hit 2% complaining that it’s the wrong sort of inflation when wages start rising at the expense of corporate profits.

    Then,they’ll be raising IR’s and watching as their banker pals start realising they’ve been swimming naked.

    These people really shouldn’t be put in charge of anything.

    • Hi Dutch

      The bit I find amazing is that central bankers and their acolytes appear unaware that after being given a job to control inflation that currently they are succeeding! After all the argument that ~0% inflation would prevent relative price changes is being proved wrong again tonight as we see further oil price falls. It’s relative price has certainly changed over the past 18 months.

      I still think that some may be silly enough to give a 4% inflation target a try….

      Oh and please remind me about you ideas for a forum as I am going to take a look at a couple of the options.

  5. In Britain, economic policy has been to support the balance sheet of banks by protecting their loans, which means not only supporting house prices, but ruining other avenues for investment.

    QE has slaughtered, for example, annuity rates, but the govt. has relaxed pension regulations such that retiring people can take on the mantle of supporting property prices by putting their pension pots into the only investment likely to show any decent sort of return.

    It may not be the same on the continent, but is it possible that ECB’s real aim is to use QE to SUPPORT other asset values, for the protection of French/German/Spanish banks?

    • Hi therrawbuzzin

      You are right to point out that there has been a shift from taking interest or annuity income to capital draw down. The catch is of course what happens if it runs out?

      As to the ECB well many places overlook that its first QE policy was to help the banks and the housing market.

      “On 2 July 2009, the Eurosystem launched its first covered bond purchase programme (CBPP1). The programme ended, as planned, on 30 June 2010 when it reached a nominal amount of €60 billion” There is still 20.6 billion left.

      It had a second go in November 2011 but was more halfhearted buying only 16.4 billions Euros. Whereas this time around it has bought 138 billion Euros already.

      • Capital drawdown for BtL is the only reasonably low-risk (since the govt. will let hell freeze over before it stops supporting property prices) investment to give a decent return.
        There is also the bonus of an asset for ones estate.
        That’s what I meant by QE + pension deregulation circumspectly supporting property prices.

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