ECB: the force awakens

Thierry Million
Written by

1st December 2015

US and European central banks have maintained a firm hold over financial market trends, by once again keeping investors on tenterhooks until their respective monetary policy committee meetings in December. Whereas the Fed is preparing to discontinue its zero interest rate policy (ZIRP), the ECB on the other hand has promised to accelerate its quantitative easing programme.

In its efforts to boost inflation from its current level of almost zero, closer to the agreed 2% target, the ECB will have to intervene heavily via one or several of the following levers.

The first of these involves prolonging the current QE programme, which is an easy decision to take, but will have no impact in the short term.

The second lever consists of increasing monthly bond purchases from €60bn to perhaps €80-85bn, whilst broadening the list of eligible securities. In this case, the central bank will drain-off a greater proportion of the bond market and therefore accentuate the scarcity effect, which is driving interest rates lower. However, the ECB is running the risk of accumulating securities weighing hundreds of billions on its balance sheet, while facing the risk that long-term yields rise as US rates are hiked.

The third lever comprises a further cut in deposit rates, beyond the current level of -0.20%. This move will cost the ECB nothing and will act as a tax levy on idle cash. It will drive investors away from the euro, just as the Fed plans to increase remuneration on the dollar. This will have an immediate affect as inflation in the euro zone will automatically increase if the euro falls to parity against the dollar.

In its combat against deflationary forces, the ECB will therefore be provided with a window of opportunity in December, which it must not miss if it wishes to obtain quick results.

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