Draghi Asset Plan Seen Falling Short as QE Bets Rise

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Mario Draghi’s latest strategy for the euro area is failing to win over economists.

More than 60 percent of the respondents in Bloomberg’s monthly survey say the European Central Bank president’s plan to steer its balance sheet toward early-2012 levels is set to fall short and a growing number predict he’ll resort to large-scale government-bond buying. Two-thirds are unhappy with the lack of details for an asset-purchase program that will start this month after the ECB declined to say how big it will be.

The survey points to possible battles ahead in the Governing Council with some officials already opposing the plan to buy asset-backed securities and covered bonds. At the International Monetary Fund’s annual meetings in Washington, Draghi again signaled that he intends to expand the ECB’s balance sheet by as much as 1 trillion euros ($1.3 trillion) to stave off deflation in the euro area.

“The ECB remained utterly vague about the details, especially about the size of the purchase program,” said Duncan de Vries, an economist at NIBC Bank in The Hague. “The advantage for the ECB from not providing all the details is that it keeps flexibility. The disadvantage is clearly that financial markets keep on questioning the ECB’s ability and willingness to fight disinflation.”

Last Tool

Investor bets on future consumer prices have deteriorated since the ECB’s Oct. 2 monetary policy meeting. Euro-area inflation slowed to 0.3 percent in September and hasn’t been near the price-stability goal of just under 2 percent since early 2013.

ECB Chief Economist Peter Praet said in Munich today that he doesn’t see any signs of deflation in the currency bloc, though “the risk of falling into negative inflation is not zero” if there are new shocks.

The IMF cut its economic forecasts for the region last week and urged the ECB to consider buying sovereign debt.

Draghi said on Oct. 11 at the IMF that expanding the ECB’s balance sheet is the last monetary tool left to revive inflation, while again declining to give a specific target.

“It’s very difficult for me to give you an exact figure at this point in time,” he told reporters. “I gave you a kind of ballpark figure, say about the size the balance sheet had at the start of 2012.”

ECB Assets

The ECB’s assets peaked at 3.1 trillion euros in the first half of 2012 and have since dropped to 2.1 trillion euros.

The purchase program plus the ECB’s long-term loans to banks will add 600 billion euros, according to the median estimate in the survey. The balance sheet will expand by 150 billion euros this year, 250 billion euros in 2015, and 200 billion euros in 2016, the survey shows.

More than half of the economists predict Draghi will eventually announce a QE program of government-debt purchases similar to those carried out by the U.S. Federal Reserve and the Bank of England. That’s up from about a third in September.

Even so, respondents forecast resistance from some policy makers on the 24-member Governing Council. Germany’s Jens Weidmann and Austria’s Ewald Nowotny both opposed the ABS plan on the grounds that it transfers too much risk to the central bank, a stance echoed by German politicians. France’s Christian Noyer rejected the structure of the program.

“We don’t expect hawkish council members to give in to these pressures without a good fight,” said Elwin de Groot, a senior market economist at Rabobank in Utrecht, Netherlands. “We also wouldn’t be surprised if a QE program for government bonds will also entail some form of conditionality. As such we don’t expect any formal announcement this year, but the first quarter of 2015 is looking increasingly likely.”

Diverging Opinions

Differences within the Governing Council were highlighted this weekend at the IMF meetings. After Draghi reaffirmed the intent to expand the ECB’s balance sheet to levels similar to those of early 2012, Weidmann responded within minutes.

“I don’t need to explain to you that there has been communicated a certain target value for the balance sheet,” the Bundesbank president said. “How formal this target value is, that’s a different question.”

The median estimate of how much the ECB will spend on ABS fell to 200 billion euros in the survey from 250 billion euros in September. Economists cut their prediction for covered-bond purchases to 150 billion euros from 160 billion euros.

While the ECB estimates that 1 trillion euros of assets meet the criteria for purchase, Executive Board member Benoit Coeure said in Washington that actual buying would be lower.

Volume Challenge

“We will certainly not be in a position to buy all of it and it would be silly to try,” he said. “The prices would be crazy, and we don’t want to do that. So we’ll only buy part.”

The median projection for borrowing under the ECB’s targeted lending plan was kept at 575 billion euros. That will be partly offset by the 315 billion euros of outstanding three-year loans that banks must pay back by early next year.

More than a third of the respondents predict the currency bloc’s economic outlook will deteriorate over the next four weeks, up from 15 percent last month. Just 7 percent expect an improvement, compared with 24 percent in September.

The ECB sees buying assets to expand its balance sheet as a way to boost inflation and at the same time revive credit in the real economy. The targeted loans are tied to the size of banks’ loan books, and the ABS purchases are intended to revive an alternative funding measure for businesses.

The challenge is finding enough low-risk private assets to buy, according to Jennifer McKeown, senior economist at Capital Economics Ltd. in London.

“While ABS purchases could better target the sectors and regions in need, the ECB will be unwilling to take on the risk that large purchases of this type would require,” she said. “We expect a QE program to be announced around the turn of the year -– perhaps in December.”