ref :- "Europe will be better off if Draghi embraces QE instead of rate cuts" , Markets Insight by Melvyn Krauss, The Financial Times
Anyone who happened to start their career by trading UK and US interest rates as the 1970s turned into the 1980s -- is anyone really that old ? -- would have thought that the idea of a monetary landscape such as we have today could only be conceived of as an interesting intellectual exercise, not something with any connection to reality.
Driven by the determination of a certain Margaret Thatcher to put the defeat of soaring inflation above all other considerations, UK rates ended 1979 at 17%. A similarly motivated Paul Volcker led the US Federal Reserve to hike rates as high as 20% in 1980. These rigid applications of monetarist theory may have brought on recessions on both sides of the Atlantic, which depending on one's point of view may or may not have been a price worth paying to slay the monster of inflation, but they were certainly effective.
You could say that almost globally today's monetary scenario turns the conditions of that particular yesteryear on their head. Interest rates, and monetary policy as a whole is still very largely a function of the rate of inflation, and in stark contrast to those times of yore the more mature economies are failing to generate enough of it -- most often deemed to be about 2%. Even decent periods of growth and falling unemployment (in places to record-equalling lows) have failed to boost prices in a world where the changing dynamics of things like demographics and technology may have become downward drivers of inflation.
Consequently, monetary policies have again become increasingly extreme, but this time on the side of easing instead of tightening. Ultra-low, negative interest rates were followed by Quantitative Easing programmes in which central banks injected stimulus by hoovering up sovereign and corporate bonds (and even ETFs in Japan) to add liquidity and suppress yields. Perhaps this was seen most dramatically in the Eurozone when European Central Bank President Mario Draghi famously promised in 2012 to "do whatever it takes" to save the Euro project by tackling high borrowing costs.
He did, too ..... by slashing rates (the ECB's deposit rate is MINUS 0.4%) and embracing QE, he reduced both long and short-term borrowing costs. It was a struggle to get those lower costs to translate into stronger (and inflationary) growth , but a strong recovery in 2017 suggested that the nut had been cracked and the ECB were able to finally call a halt to QE in December 2018.
And now, just six months later, it looks as though they may have to start it again .....at least, that's one of the options.
Last month Mr Draghi used the ECB jaunt to Sintra to make pretty clear that unless there were improvements in the Eurozone's inflation outlook (and there are few signs of it), there would have to be a fresh round of stimulus measures. Assuming that's the case the question is, what form it will it take? Rate cuts or more Quantitative Easing ?
You may wonder whether a deposit rate of -0.4% , which means that banks pay to leave money with the central bank overnight, leaves much room for rate cuts anyway but Mr Krauss is suggesting that the ECB would be better to go down the route of a resumption of QE for three other reasons :
1. The inevitable accusation by President Trump of currency manipulation -- and the likelihood of further descent into trade conflict -- in the event of rate cuts. Mr Trump has already accused Mr Draghi and the ECB of this, and whilst a further fall in yields associated with QE would work against the euro, cutting short-term rates is both more direct and more obvious.
2. A new round of QE would be likely to be much more effective in sending another "we'll do what it takes" message than further minimal cuts to already negative rates. But for that to be the case the ECB is going to have get the rules changed with regard to the proportion of how many bonds of each Eurozone nation it is allowed to purchase. As it stands, since Germany has the largest GDP the ECB is permitted to buy more German Bunds than any other sovereign bond -- but spending-shy Germany does not issue a huge amount of debt (and German 10yr Bunds are already yielding MINUS.38%). The impression is therefore that QE may be a weapon lacking ammunition. If the ECB was allowed to buy bonds in amounts disproportionate to the size of the issuing nations' GDP, it would be a much more effective tool.
3. Because the ECB runs its QE programmes over longer periods (six months, a year or even longer), a commitment to it would tie in the retiring Mr Draghi's successor. We now know that the ECB's next president will Christine Lagarde, current boss of the IMF, and there's no doubting the fact that a longer programme of QE would be binding on her actions in a way that a rate cut wouldn't -- after all, a rate cut could turn out to be a case of "One and Done".
We can't argue with Mr Krauss' logic one bit .... although that may have something to do with the fact that, just like it would with those ancient deposit traders, we find the idea of headline rates going further and further into negative territory a hard one to digest.
**** On the subject of Ms Lagarde, some respected judges have called her surprise appointment "inspired ". We have no reason to argue with that either, but as a former French Finance Minister, she will have to overcome accusations that this was a political appointment, part of the grand round of habitual and not altogether seemly horse-trading that accompanies major EU appointments. More to the point, she has no experience as a central banker and therefore, by definition, of devising and implementing monetary policy. We wish her luck .....