ECB set to bow to German pressure over QE

16/1/2015

By Claire Jones

The European Central Bank is set to unveil a programme of mass bond-buying next week to save the eurozone from deflation, but has bowed to German pressure to ensure that its taxpayers are not liable for any losses incurred on other countries’ debt.

Policy makers in Frankfurt are expected to take the momentous decision to embark on quantitative easing on Thursday, with the most likely option at this stage for the ECB to force the 19 national central banks that make up the eurozone to stand behind their own sovereign bonds.

The decision comes just weeks after it emerged that eurozone prices fell in the year to December, for the first time in five years. Market expectations of eurozone inflation in the longer term are also close to record lows.

The move will bring the ECB closer in line with the US Federal Reserve and the Bank of England which adopted QE in the wake of the global financial crisis.

But ECB officials have reluctantly concluded that introducing full-blown quantitative easing is impossible in the face of implacable opposition from the German political and economic establishment.

Chancellor Angela Merkel remains privately sceptical about ECB bond-buying in principle, fearing such intervention will ease pressure on spendthrift member states to introduce tough economic reforms and would amount to fiscal union by the backdoor. Neither of the German members on the ECB’s governing council are expected to support the decision to embark on QE next week.

A compromise over risk-sharing does, however, raise the chances that Mario Draghi, ECB president, will be able to force through a large package of purchases of at least €500bn-worth of government bonds, or announce an open-ended commitment to buy sovereign debt until inflation approaches the central bank’s target of just below 2 per cent.

Mr Draghi is hopeful that bond-buying will push banks out of government debt and encourage them to lend more to the private sector, especially as the bonds will be held to maturity.

Markets would prefer Mr Draghi to compromise on the principle of handing the responsibility for losses to national central banks if that meant the ECB could buy more bonds.

However, analysts have also warned that if the ECB were to break with tradition and abandon the principle of loss sharing, questions could be raised about its commitment to maintaining the currency union in its current guise.

“There are a series of trade-offs involved in [designing QE] and whatever is announced will probably not satisfy everyone,” said Ken Wattret, economist at BNP Paribas. “Any adverse impact stemming from a reluctance to mutualise risk could be offset by a strong signal that the ECB is willing to buy in large scale in order to raise inflation expectations.”

The precise details of the QE programme are the subject of delicate discussions within the governing council where there has been strong opposition to ECB bond-buying, especially sovereign debt.

The ECB president believes QE can raise inflation and stabilise inflation expectations. However, he wants to form as strong a consensus as possible in favour of the QE package, fearing that a high level of dissent would dent confidence in the ECB’s commitment to its inflation target.

Jens Weidmann, the Bundesbank president who is the most vocal opponent on the governing council to QE, has indicated that sovereign bond buying without placing the risk on the books of the national central banks would pave the way for an illegal redistribution of risks between eurozone taxpayers.

Germany’s finance ministry declined to comment on Friday on the division of potential losses under QE. Berlin is quietly supportive of Mr Weidmann’s loss-splitting proposal, but it is unwilling to publicly back the Bundebsank president.

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