THE UGLY…
“Full blown QE may be announced in Q1 next year,” says T Rowe’s Orchard, “but people would have to see there are no other options before they are willing to take more steps.”
Historically, new stimulus announced by the ECB has always been a unanimous decision, but that changed to a “ comfortable majority” for the September package. Jens Weidmann, president of Germany’s Bundesbank is assumed to be among those who voted against the measures.
A split in the ECB’s policy setting committee could prove ugly for Europe and investors if it were to worsen or prevent Draghi from delivering his promise to do “whatever it takes”.
“Europe is in a big enough hole already. If investors think policy makers are divided over future policy, then the whole European project could be open to question again,” RMG’s Richardson believes. “This would clearly not be a good outcome for European asset prices or the euro.”
Draghi faces a considerably more difficult job than his counterparts at the Fed or Bank of England, for example, because the range of economies directly affected by his policies are very diverse politically, culturally and economically. He is also significantly less powerful in being able to steer policy given those differences.
His relationship with Germany has proven particularly difficult with regards to taking quantitative measures in the eurozone and could be decisive in whether Draghi is indeed able to do “whatever it takes” to save the euro.
Whether the ECB does finally go for fullblown quantitative easing in the form of sovereign bond purchases will depend in large part on Germany’s reaction and resistance. German Finance Minister, Wolfgang Schaeuble, is known to believe monetary policy has already gone far enough, even before the recently announced stimulus package, and Angela Merkel was less than happy with Draghi’s incursion into fiscal policy at Jackson Hole.
Germany has already challenged the legality of what Draghi promised in July 2012.The European Court of Justice, the region’s highest court, is weighing whether Draghi overstepped the ECB’s powers in 2012 with the promise to buy the debt of stressed countries.
Furthermore, because markets are already expecting full-blown QE to arrive at some point in the not-too-distant future, they would have to be significantly positively surprised for such a programme to have a similar impact as these measures have elsewhere.
“The shock needs to be proportionately much greater versus the Fed’s QE3, for example, to mitigate what is already priced in,” Aon Hewitt’s Datta believes. “In that case, the split that is already present becomes a much greater issue.”
THE DRAGHI DILEMMA
Draghi faces a considerable dilemma as the clouds of doubt descend. He has three options ahead, none of which spell positive news for investors.
First, he could reach agreement with Germany. However, in order to generate the desired 2% inflation in Europe’s periphery, Germany will have to be pushed to around 4%, which it is highly reluctant to allow. The recent slowdown in the German economy potentially gives Draghi more scope to move, which many market experts hope will be the case. But, for an ECB that tends not to act until all other routes have been exhausted, this may be too much to hope for.
“Even after another quarter of poor growth Germany is likely to simply shrug its shoulders,” Datta says.
If that is the case, the economic situation in Europe, including its core, would have to have deteriorated very significantly to get to a point where the Germans approved sovereign bond buying.
Second, Draghi can push through further QE with a majority, but without Germany. “If he does that it would reveal how desperate the ECB is,” RMG’s Richardson states. “Markets will prepare for a break-up of the euro as it will demonstrate there is no unity to speak of.”
Third, Draghi proves unable to do whatever it takes, but rather whatever he can, to rescue the euro. If that is the case, his credibility is significantly undermined and markets face a sharp and painful return to crisis as the efficacy of its whole existence comes screaming back into focus.
“If Draghi can’t push full-blown QE through, it would take markets back to how they were prior to his 2012 speech,” according to Richardson.
All three options spell further gloom for investors and it is unclear how things will pan out, but one thing is certain – Europe will have to get a lot worse before it gets better.
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