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Mario Draghi: The European Financial Savant?

Big Talk and Big Action by Mario Draghi!

Europe has been in dire straits economically, what with poor productivity, high unemployment, historically low interest rates and the threat of deflation looming. While consensus has been hard to come by, the European Central Bank (ECB) under the stewardship of Mario Draghi has decided upon a quantitative easing program worth a staggering €1.14 trillion. That translates into approximately €60 billion per month in asset repurchases. The plan is nothing new, but how it plays out is less certain – given the current state of the global economy. The ECB has taken a 19-month timeline for enacting its stimulus package and at least a third of polled economists agree that it has precisely the right ingredients to whip up a recovery.

What is at Stake with the QE Program?

Europe’s financial stability appears to be the strategic objective of enacting this quantitative easing program. The ECB had set an inflation target of 2% - much the same of the Bank of England and the Federal Reserve Bank. However, the current harmonized inflation rate in the EU is hovering around the -0.62% mark. The December 2014 – January 2015 figure was reported at -1.56% , significantly lower than the present figure. Getting the inflation rate where it should be is an absolute priority for the ECB for several reasons. If the rate of inflation is falling, it means that the velocity of money flow is incredibly slow. Simply put: consumers are not spending money in the hopes that prices will drop further.

Europe has several other major problems looming, not least of which is directly associated with what’s happening in the U.S. The FOMC is expected to announce when (or if) it intends hiking interest rates. This information is especially important for Europe since a higher interest rate in the U.S. will lead to massive selloffs of euros in favor of dollars. As European investors see the value of the greenback rising and the value of the euro plunging, it makes sense to sell euros and buy dollars. Regardless, the QE policy by the ECB will go on as intended. Mario Draghi is projecting that QE will stay in place until at least September of 2016, but at least 18% of polled economists believe that the measures will stay in place until 2017.

Quantitative Easing Measures Are Nothing New to the ECB

The QE measures are expected to flood the European economy with money – lots of it. The QE program will focus its expenditures on European government bonds, covered bonds, agency debt and a small portion focused on asset-backed securities. As yet, corporate bonds are off the table but that too may change.  By the end of 2016 the European Central Bank’s balance sheet will top out at €3.2 trillion – presently it is at €2.8 trillion.  While QE worked in singular countries like Japan and U.S. and in the United Kingdom, it is not a certain bet in the multifaceted, multi-region European Union. Part of the problem is that ECB policies must be met with reciprocal actions by member governments. These include things like austerity measures, but what happened in Greece is a painful near-memory that the eurozone can ill afford to entertain.  Another concern for Europe is the dreaded ‘Asset Bubble Effect’ where all this money goes towards fuelling assets leading to inflated stock prices on European bourses. 


Mario Draghi: The European Financial Savant?

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