After sustaining long disagreements with German leaders, the European Central Bank finally announced Draghi’s victory withto be launched in Europe. in the Euro would witness bond purchases of 60 Billion Euros per month for at least a horizon of 19 months in addition to the existing scheme of purchasing 10 Billion Euros with covered bonds. The programme marked its official debut in Europe on March 9th however the markets had begun pricing in the much anticipated measure sending bond yields falling and average deposit rates hovering around the zero lower bound.
The latest feedback from Portugal – a ‘peripheral country’ with relatively wider spreads with 30 year yields touching 2.23% on Friday (03/13/15) - the lowest since 2006. The euro has maintained its decline relative to the dollar and much of it translating to improving stock market performance as the graphic below depicts:
Despite markets reacting optimistically to the unconventional monetary policy and ECB improving its growth forecast to 1.5% (from 1%) for the Euro zone, the eventual success/sustainability of the results depend crucially on how strongly lower rates trickle down through the financial system and in turn prop up the moribund state of demand plaguing the Euro zone.
One of the major differences between the US and European financial markets is that companies resort to bank loans for primary borrowing purposes in the Euro as opposed to the US where the corporate bond market is very well developed. Thus eventual success hinges on how well the banks are able to stimulate investment by advancing loans to profitable/risky moderate opportunities which are made difficult by the adverse selection problem in the face of a region recovering from recession. Also, with falling bond yields on government bonds created liquidity in the high yield corporate bond markets in the US and thus providing a strong stimulus for investment.
As the Euro weakens (currently almost at par with the dollar,at $1.06) it will be important to capitalize on stronger export opportunities to stimulate growth. With exports accounting for a quarter of the GDP in the Euro area, this will be the most important channel to establish competitiveness and stimulate export fuelled growth.
Another area of concern for the ECB could be the fact that the asset purchase program conducted by the FED was at a time when prices were depressed to their lowest levels and interest rates were higher (meaning bond prices lower) and thus guaranteeing profit making opportunities for the US Central Bank. Thus many argue that the missing ‘’shock and awe’’ impact ofin the Euro zone might trigger capital losses for the national banks. Many analysts are also of the opinion that infrastructure investment would perhaps be a stronger channel for stimulating growth.
However while we wait for the long run trends to emerge, the near future signals an air of optimism. With global stock markets recording a 5.3% increase in February, the world economy posts a favourable outlook so far.
So what are your thoughts and predictions for Quantitative Easing in the Euro?
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