Draghi Commits to Trillion-Euro QE in Deflation Fight

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ECB President Mario Draghi
European Central Bank President Mario Draghi looks on during a news conference to announce the bank's interest rate decision at the ECB headquarters in Frankfurt, today. Photographer: Martin Leissl/Bloomberg

Mario Draghi led the European Central Bank into a new era, committing to a quantitative easing program worth at least 1.1 trillion euros ($1.3 trillion) to counter the threat of a deflationary spiral.

The ECB president shrugged off determined opposition led by German officials with a pledge to buy 60 billion euros every month through September next year in a once-and-for-all push to put more cash into circulation and revive inflation. To assuage critics, the region’s 19 national central banks will make 80 percent of the purchases and take on any risk they carry.

A near-stagnant economy and outright declines in consumer prices forced Draghi’s hand six years after the Federal Reserve took a similar step -- and three months after the U.S. central bank ended its purchases. The 67-year-old Italian’s gamble is that the benefits of QE -- should it work -- outweigh the threat of a backlash in Germany.

“One could argue that this type of approach Draghi is using should have been applied much earlier, which would have gotten Europe on a similar kind of platform the U.S. was on,” Stephen Schwarzman, chairman of the Blackstone Group LP, said in a Bloomberg Television interview at the World Economic Forum in Davos. “It is never too late to do the right thing.”

‘Trust in Mario’

Investors reacted by selling the euro and buying European stocks. The shared currency declined to an 11-year low, losing 2.1 percent to $1.1370 at 7:30 p.m. in Frankfurt. The Euro Stoxx 50 added 1.7 percent. Athanasios Vamvakidis, head of G-10 foreign-exchange strategy at Bank of America Merrill Lynch, said the plan was at the high end of market expectations.

“We’ve seen over the last few years you have to trust in Mario,” Laurence Fink, chief executive officer of BlackRock Inc., said in Davos. “The market should never, as we have seen now, the market should not doubt Mario.”

The ECB’s shift exacerbates an emerging global split. While the Fed is considering when to tighten credit, central banks in Denmark, Turkey, India, Canada and Peru all announced surprise rate cuts in the past week. The Swiss National Bank shocked investors by dropping a cap on the franc.

The ECB’s Governing Council agreed to a faster pace of purchases than Draghi had proposed when they first gathered on Wednesday. While the size of the plan was the same as one cited by euro-zone central bank officials yesterday, buying was accelerated by 10 billion euros a month for completion three months sooner.

Strongest Dissents

Bundesbank President Jens Weidmann and Sabine Lautenschlaeger, the German member of the ECB’s Executive Board, reiterated their opposition to the QE decision with the strongest dissents, according to euro-area central bank officials with knowledge of the discussions. The Austrian, Dutch, and Estonian central bank governors were also said to express reservations.

Draghi made concessions to such critics. Reflecting the drive for consensus that has been a hallmark of Europe’s response to years of rolling crises, Draghi allowed the inclusion of a limit to the risks that the Eurosystem as a whole will be exposed to.

The ECB “decided to launch an expanded asset-program encompassing the existing purchase programs of ABS and covered bonds,” Draghi told reporters in Frankfurt. “We see sustained adjustment in the path of inflation which is consistent with our aim of achieving our aim of inflation rates close to but below 2 percent.”

Purchase Impact

ECB projections show the announced measures should boost the euro area’s inflation rate by 0.4 percentage point this year and 0.3 percentage point in 2016, a euro-area central bank official said. He and other officials cited anonymously on the decision didn’t want to be identified because the ECB’s discussions and assessments are private.

The ECB will hold a share of the securities while requiring individual central banks to conduct the bond purchases in the hope that will make nations more responsible for the management of their economies.

Monthly acquisitions will probably comprise about 45 billion euros of sovereign debt, 5 billion euros of bonds issued by institutions and agencies, and 10 billion euros under existing programs for asset-backed securities and covered bonds, according to another official.

Draghi said the ECB would limit its purchases to 25 percent of any single bond issuance, and 33 percent of the instruments available from one issuer. The debt held by the ECB would not be senior to other investors’ purchases.

Hypothetical Losses

“With regard to sharing of hypothetical losses, purchases of securities of European institutions, which will be 12 percent of additional purchases, will be subject to loss sharing,” the central banker said. “The ECB will hold 8 percent of additional asset purchases. That implies that 20 percent of additional purchases will be subject to a regime of risk sharing.”

The curbs are aimed at calming concerns aired most loudly in Germany that the ECB is unfairly aiding uncompetitive nations that do little to help themselves. Those critics also say it’s an unwelcome step into politics that effectively mutualizes debt risks and finances governments through the back door. Weidmann has described quantitative easing as “sweet poison” for governments.

“We took these concerns into account and that’s why this decision will mitigate those concerns,” Draghi said.

That matters now because Greek elections in three days could bring to power a party seeking to renegotiate the country’s debts, most of which are held by European taxpayers.

Junk Rated

Draghi held out the prospect that junk-rated Greece could still benefit from asset purchases by July if it remains in a European-Union monitored program.

“There’s a waiver that has to remain in place, and there’s this 33 percent issuer limit,” Draghi said. “If all other conditions are in place, we could buy bonds I believe in July because there will be some large redemptions.”

The downside of the horse-trading is that the program potentially packs less punch and the unwillingness to share risk exposes fault lines in the monetary union. If investors reject it as insufficient, the ECB may have to do even more later.

“The ECB left the option open to continue the purchases beyond September 2016,” said Christian Schulz, senior euro-area economist at Berenberg Bank in London. “Expectations have risen considerably in recent days, but the ECB still managed to beat most today.”

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