The easy money era in Europe is coming to an end. Germany is happy about that, for sure. Investors in the Italian debt market, Europe’s largest, might not be.
Ten years after the start of the financial crisis, the European Central Bank has signaled that – finally – it is willing and ready to call it quits. Its firefighting campaign, which has pumped €2.5-trillion into the euro zone through the landmark quantitative easing program, is winding down.
The ECB, under President Mario Draghi, is saying basta – enough. Its job is largely done and the 19 euro zone countries are pretty much on their own. That’s because growth is fairly strong and inflation, while still below the ECB’s 2-per-cent target, is intact and seems in no danger of going in reverse. In other words, mission accomplished, even if it took a lot longer than expected.
The ECB was a global laggard. The U.S. Federal Reserve ended its QE program in 2014, a year before it started to jack up interest rates. And the ECB will remain a global laggard for a while yet: That’s because it intends to keep interest rates at record lows until at least mid-2019.
The news of no imminent Fed-style rate hike knocked 1 per cent off the value of the euro against the U.S. dollar, the biggest daily drop since October. European exporters will be happy. But the euro may have fallen also because the end of QE will remove a key support pillar for the Italian bond market, which is the new source of worry in the European debt markets.
The Thursday announcement by the ECB’s governing council, made in the Latvian capital, Riga, did not come as a shock and QE will not end with a bang. The ECB will keep its asset purchase program intact, at €30-billion a month, through September, after which it will drop to half that rate through the end of the year.
Then no more QE, at least in theory. But the ECB is keeping the door slightly ajar, just in case economic disaster strikes. Mr. Draghi obliquely referred to the Donald Trump-inspired protectionist moves when he noted that “we have an unquestioned increase in the global geopolitical uncertainty.”
He was careful to play down the risks posed by the populist, euroskeptic government in Italy, but the Italian question could not have been far from his mind. The populist government’s arrival in late May sent Italian bond yields soaring, rattling the European bond markets. In its release, the ECB said asset purchases will end “subject to incoming data” and that the ECB’s governing council “stands ready” to adjust its policy instruments as needed.
It was a classy way out for the ECB. Casten Brzeski, ING’s chief economist in Germany, said in a note: “Today’s decision is a truly Solomonic compromise between the hawks and the doves. The hawks finally got their end-date for QE, while the doves still have their door open for more if needed. Nicely done.”
Some countries – notably Germany, the main hawk – will be delighted that Mr. Draghi has announced the dismantling of the QE crutch.
But the investors in the debt of the euro zone’s weak Mediterranean countries in general and Italy in particular will have a different view of the end of QE. For them, QE and Mr. Draghi’s other firefighting programs were a godsend. Thanks to them, Italian bond yields plummeted from crisis levels seen in 2011 and 2012. Even today, in spite of the recent rise in Italian yields, Italy can still borrow 10-year money more cheaply than the United States.
But how long will that last? Italy’s populist government is sending out signals that it’s fed up with the European project, that the euro’s introduction almost 20 years ago did Italy no favours, and that its spending and taxation programs could blow through the roof of the European Union’s deficit cap.
QE is on its way out, and that’s a good thing. But it appears the ECB is keeping its options open in case Italy presents Europe with a fresh crisis, even if Mr. Draghi would never admit so, and that’s a good thing too.