For three years, the European Central Bank’s asset purchase programme has squeezed spreads, muffled volatility and propped up prices in the name of price stability.
While the torrent of cheap money has likely contributed to the recovery of European economic growth, many believe that the bank’s extraordinarily accommodative monetary policy is simply storing up problems for the future.
When the central bank comes in for its share of criticism, its traditional cry is “We are data-driven”. We were warned up front that the ECB would do “whatever it takes” in its quest to push European inflation to “close to but below 2%”.
But many have felt that the €2.5tr quantitative easing programme was a failure. European inflation remained subdued by slack wage growth even as unemployment fell and the continent’s economy began to grow at a pace the envy of the rest of the developed world.
Low quality employment (the gig economy and zero hours contracts) was blamed for flat wages and it seemed that no amount of cash pushed through Europe’s securities markets was going to make a difference.
Investors believed the asset purchase programme would end only when it had absorbed its universe of eligible assets, rather than when it was deemed to have achieved its aims.
But the doubters have largely been silenced.
Eurozone inflation hit 1.9% in May. While this coincides with a sharp rise in the price of oil, Peter Praet, the ECB’s chief economist, struck a more confident note in his speech on June 6 and some of the more hawkish members of the governing council agree.
The speech and subsequent quotes were interpreted by many as preparatory signalling for an announcement of the end of QE.
But, while inflation has returned, economic growth has slackened. Technically, that should be of only indirect interest to the ECB. Its mandate is price stability, as represented by a level of inflation of close to but below 2%.
However, the ECB appears to have, in practice, taken on an additional role in nursing the European recovery, shepherding it through patches of volatility and encouraging the shoots of self-sustaining growth with cheap cash.
With Italy’s political machinations posing threats to the integrity of the eurozone, the ECB may well be reluctant to tell Europe that it’s about to go cold turkey.
Despite the months of growth, Europe’s problems remain threatening.
It is a region of extreme diversity only awkwardly homogenised by the necessities of its single currency. Even the recent spike in inflation was driven by wage growth in Germany. In Spain and Greece, unemployment remains a terrible blight; Italian growth is still lagging behind; the refugee crisis may be out of the headlines, but has yet to be addressed; and populism and nationalism are sprouting across the continent.
Either this Thursday, or at its meeting in July, the ECB will likely announce either a definitive end to quantitative easing in September, or an intermediate €15bn tapering stage.
If an end to QE is announced, we can expect credit spreads and new issue premiums to widen and the cost of debt to rise. The tightening monetary conditions might put too much strain on Europe’s fragile economy.
But, if the ECB opts to kick the can to July, and then announces tapering, rather than the end of QE, it will suggest a greater fear for the eurozone’s economy than the bank's mandate suggests. Should a recession surface, the central bank will have limited ammunition with which to mitigate its effects. If growth stops before monetary policy is tightened, Europe could be in serious trouble.
With inflation on target, but growth flagging, we shall soon see just how strong the ECB’s adherence to its inflation mandate is.