Eurozone QE set to arrive, but with conditions

18/1/2015

By Claire Jones

The European Central Bank will this week set out plans for an ambitious programme of sovereign bond buying, as the bank steps up its efforts to stave off deflation and boost the eurozone’s flagging economy.

The ECB has for several months signalled its intention to follow the US Federal Reserve and Bank of England by initiating quantitative easing. But agreeing a format that Mario Draghi, the bank’s president, could sell to Europe’s policy makers has gone right down to the wire.

Details about the size of the programme, and what exactly the ECB will buy, are still to be revealed. One area where the bank is set to bend to QE sceptics, however, is to break with tradition and force national central banks to take on the losses for their national debt.

The ECB could agree to chip in by buying the bonds of the European Investment Bank. Policy makers could allow Greece, and others with junk ratings on their sovereign debt, to buy bonds by insisting they only do so if their countries remain in European Commission reform programmes.

Placing the burden for losses on the shoulders of national central banks is unlikely to win Mr Draghi support from Jens Weidmann, the Bundesbank president and governing council member who has said QE without national responsibility for losses would contravene EU law. Nor is Sabine Lautenschläger, the council’s other German member, set to back the ECB chief. But the vast majority of the eurozone’s monetary policy makers are likely to support QE.

Klaas Knot, head of the Dutch central bank, who is among the council’s sceptics on the merits of bond buying, has signalled he would be prepared to switch sides if national central banks agree to buy their own debt. Mr Knot told German news magazine Der Spiegel this week that such a compromise “would lower the danger of there being an undesired redistribution of financial risks”.

The plan would also appease German taxpayers’ fears that they would be punished for what they view as other member states’ profligacy. The expectation that Greece’s leftwing Syriza party, which has said it wants to restructure the country’s debt, will emerge as the winner in this month’s elections has exacerbated those concerns.

In Berlin, Chancellor Angela Merkel believes the eurozone is now in a stronger position than it was in 2012, when she supported Mr Draghi’s pledge to buy sovereign debt in potentially unlimited quantities to prevent a possible break-up of the currency area.

Yet the legal implications of national central banks taking on responsibility for any losses are complex.

While the ECB is forbidden by EU law from voluntarily taking part in a restructuring or rescheduling of its holdings of government debt, it is unclear whether the central bank would have to shoulder losses if a restructuring was forced on all creditors.

Supporters of the compromise claim governments are less likely to force a restructuring on their own central bank, from which they receive an annual payout as long as the monetary authority has made a profit. A central bank would mark the cost of any debt haircut as a loss.

Others disagree. “The argument that risk sharing by the ECB gives countries an incentive to default is weak,” said Guntram Wolff, director of Bruegel, an economic think-tank. “The chance to pass on some of the burden to the ECB is not the reason governments restructure their debts, as the central bank is only ever going to hold a small portion of their bonds.”

Market economists would prefer Mr Draghi to compromise on risk sharing rather than the size of any package. But the ECB’s proposed fix has its critics, who warn that scrapping its commitment to risk sharing sends a dangerous message on the future of the eurozone.

Marcel Fratzscher, a former ECB official who is now president of DIW, a Berlin-based economic research institute, said: “It would signal the end of monetary union. It would mean less risk sharing and less common effort.”

The ECB’s earlier sovereign debt purchases, made as part of its crisis-fighting Securities Markets Programme, shared the burden for any losses or profits between the national central banks according to the ECB’s capital key, their subscribed share of its capital.

David Marsh, managing director of OMFIF, a forum for central banks and financiers, said Berlin and the Bundesbank should have been aware for some time that monetary union would result in Germany shouldering some of the losses for debtor states, such as Greece.

“Germany knows that Europe is very important politically, but finds it very difficult to look at the economic issues strategically,” Mr Marsh said.

“One reason for criticising German officials is that they did not see that the euro area’s successive crises of competitiveness, balance of payments disequilibria and unsustainable debt would inevitably require restructuring, implacably pitting debtors against creditors.”

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