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Analysis
Waiting – again – for an ECB decision

Waiting – again – for an ECB decision

Odds are still stacked against full-scale QE 

by David Marsh

Mon 22 Dec 2014

A great deal depends on the European Central Bank governing council when it decides Yes or No on full-scale quantitative easing at its first monetary policy meeting of the New Year on 22 January. Jens Weidmann, the frequently nay-saying Bundesbank president, last week launched the strongest and most detailed opposition so far to across-the-board government bond purchases to flood capital markets with additional liquidity and bring inflation nearer to the ECB’s target of below but close to 2%.

By laying out his thoughts to the prestigious Frankfurt International Journalists Club, Weidmann was indicating either quiet confidence – or reckless desperation in view of the likelihood of being heavily outvoted at the council meeting. In my view, it is the former.

Almost certainly, he was spelling out arguments that, in private, he will be outlining (or has already outlined) to his former boss, Chancellor Angela Merkel, for whom he worked as economic adviser in 2006-11.

In short order, Weidmann claims that full-scale QE is unnecessary, risky, divisive, insecure, inflationary and counter-productive. Apart from that, he is a great fan.

For the first time Weidmann dropped clear hints of a legal filibuster under which the Bundesbank could call either for bond purchases to be limited to triple A-rated countries – or, even more controversially (and potentially fatally for monetary union), for euro members to purchase, at their own risk, solely their own governments’ bonds.

Many market participants betting on a Yes to QE on 22 January trust Merkel will back Mario Draghi, the ECB president, against her erstwhile protégé. They see her repeating her support for Draghi in September 2012 over the never-used Outright Monetary Transactions programme (which Weidmann opposed), foreseeing selective ECB bond purchases for countries that agreed additional austerity measures.

In my view, such interpretations ignore the very significant differences between the two episodes.

In September 2012 Draghi unveiled an initiative to protect the euro bloc from break-up, using the ploy of potential and highly conditional ECB bond purchases to aid countries that had overcome further tough reform-and-austerity hurdles. Two years ago, Merkel instinctively backed the Draghi measures. This was not really surprising. He effectively relieved her of the need to take highly unpopular, probably unrealisable action in the German parliament to put taxpayers’ money directly at risk to aid struggling euro members.

This time round, it’s rather different. Merkel is hardly likely to disavow the Bundesbank chief in the No.1 area of the Bundesbank’s expertise – defeating inflation. The sheer scale of Weidmann’s political, technical and economic objections indicates that he has at his disposal some weighty instruments to deploy against QE, including a legalistic Bundesbank opt-out from any collective bond-buying.

This could be a gigantic Bundesbank bluff. But, just as likely, the Bundesbank’s hint of an opt-out could be for real – in which case Draghi would be advised not to call a vote on 22 January for fear of suffering a monumental rebuff.

Beyond the Bundesbank’s manoeuvrings, three sets of political factors could upset the QE bandwagon.

First, if Greece is forced to hold an early general election in February as a result of machinations in Athens over choosing a new president, then the ECB would be highly unlikely to start an activist bond-buying programme in the midst of a fraught Greek polling campaign.

It is difficult to imagine the enormous profits available for speculators if the ECB turns itself into the buyer-of-last-resort for Greece’s bonds while they are in free fall ahead of an election many fear could lead to another Greek bust-up. Equally difficult to imagine: the consequences if the ECB decided to buy all governments bonds apart from those looking dubious during an election. Most likely in such a scenario is that the ECB does nothing.

Second, in the next few weeks, Draghi himself could become caught up in speculation that he will replace Giorgio Napolitano, the veteran Italian president, who has indicated that he wishes to step down early in the New Year.

A revival of the much-canvassed, much-denied idea that Draghi could leave his Frankfurt post after just three years would effectively paralyse any process leading to QE. The thought that Draghi could launch QE and then depart in a blaze of glory for Rome, leaving the ECB to carry through a bond-purchase programme highly beneficial to Italian state finances, must be the New Year’s most improbable blockbuster film script.

Third, if the ECB does indeed postpone any QE vote on 22 January, it is highly unlikely to take any such decision at its next monetary council meeting on 5 March, which takes place in Cyprus – a country with capital controls, that has effectively put itself beyond the regular structure of monetary union. The ECB believes in symbolism. Deciding QE in Nicosia would not be a propitious step.

Many people have ringed round the date of 22 January as Decision Day. I believe still it will be a No.

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