Why Draghi will watch Greece as he launches eurozone QE

15/1/2015

By Ralph Atkins

Political factors are important when anticipating ECB actions

Benoît Cœuré is one of Europe’s most powerful economists. As a European Central Bank executive board member he has a crucial role in managing eurozone crises. He is also smart, giving exactly the right answer when asked by Germany’s Die Welt newspaper whether Greek elections on January 25 would affect next week’s decision on a eurozone quantitative easing programme. “They have absolutely no influence on us whatsoever,” he insisted.

A central bank, of course, could not admit being swayed by politicians. But was Mr Cœuré’s answer completely accurate? The ECB would be crazy if it had not considered the wisdom of launching a massive government bond-buying programme to avert a dangerous eurozone-wide deflationary slump just three days before a Greek poll that could see the anti-reform Syriza party taking power — not least given German sensitivities towards riding to Greece’s rescue. At least some on the ECB’s governing council have qualms. “I’d personally find announcing a bond-buying programme including Greek government bonds in January problematic,” Ardo Hansson, Estonia’s central bank governor, told Bloomberg recently.

The dilemma highlights the importance markets should attach to political factors when anticipating ECB actions. The bank successfully sidestepped one political minefield this week when a German legal challenge to the ECB’s right to intervene in bond markets was in effect dismissed in a preliminary opinion by the European Court of Justice. But Greece is just one of a number of other non-economic factors the ECB has to weigh — which also include the effect its decisions have on governments’ incentives to implement essential structural reforms and on its own political legitimacy; ultimately independent central bankers must maintain the confidence of the public — not just in Germany.

That all makes it harder to predict ECB actions and their effect on markets, requiring the skills of games theorists and political analysts as well as economists. Does this mean the ECB will be less effective? Possibly, particularly if you believe the success of US Federal Reserve QE programmes lies in their relative simplicity and the powerful share market rallies they drove. Alternatively you could argue that economics — the outlook for eurozone inflation — will still determine whether the ECB launches QE; politics will only shape the details, arguably making it better suited longer term to Europe’s monetary union.

All central banks are political to some extent. The Fed faces criticism from US politicians over its crisis-fighting actions. The ECB, however, finds itself more often in a position where it has direct influence over the course of political events. Operating across 19 economies without a single government gives it unique powers with which it is not comfortable and exercises with caution.

The ECB is not afraid to play hardball, however. When the eurozone crisis was at its most intense, the ECB‘s bond buying was explicitly made conditional on reforms being implemented in Spain and Italy. The pressure applied by Jean-Claude Trichet, then ECB president, on Dublin was revealed late last year when his correspondence with the Irish finance minister was published.

Greece may require a similarly steely stance by Mario Draghi, ECB president since November 2011. The ECB has the power to pull the plug on Greek banks, threatening the country’s financial collapse. Last week, it made clear that continuing access to its liquidity required Greece sticking to deals struck with its international creditors. A similar condition could be applied to bond buying under a QE programme.

Alternatively, Mr Draghi might next week announce just the outlines of its proposed package, perhaps setting out its expected total size, with details to come only later. Given the impact of QE programmes is greatest at their launch, a drawn out announcement could boost the chances of success — while also keeping Greek politicians under pressure. “The more aggressive they [the ECB] are in communicating easing, the more likely they will be to leave Greece concerned it will not be directly beneficial,” reckons Brian Singer, head of dynamic allocation at William Blair, a Chicago-based fund manager. But keeping Greece on track, while simultaneously defeating eurozone deflation threats, avoiding other political pitfalls — and not confusing markets, will test even the smartest economist.

Πηγή