Eurozone QE will be the most inefficient yet – CNBC Comment
THE MARKET is expecting confirmation of a QE plan from European Central Bank (ECB) president Mario Draghi very soon. Indeed, CNBC learned yesterday that the ECB will more than likely base its highly-anticipated sovereign bond buying on the size of contributions made by national central banks. But whatever form it takes, it will almost certainly be the most inefficient bout of QE seen by markets since the onset of the financial crisis.
We already know that yields in Europe are extraordinarily low, and that these have not yet fed through to the broader economy. Further, whether based on GDP, bond market size, central bank contribution, or sovereign rating, bond buying will be focused towards the core of Germany, Italy and France. This will likely have little incremental effect in spurring consumers and firms to borrow.
We won’t be able to decide if US QE worked for at least another few years. If – and I stress if – it did, it will have been because it fed through to companies due to a well-developed bond market, and because the US’s consumption-led economy has strong multiplier effects. It is unlikely that the ECB’s bond-buying programme will be so lucky.
Why does the average investor or business borrow money? As GaveKal recently highlighted, it is either to increase capital spending to expand, or for financial engineering in order to purchase an existing cash flow (where its value is higher than the cost of debt required to own it). The former increases capital stock, the latter transfers its ownership.
There is no doubt that US QE has led to both taking place – arguably far more financial engineering than capital generation. The same will be true in Europe, but the balance will be even further towards the financial engineering side.
The process by which QE (may have) worked in the US saw banks sell bonds in exchange for “cash” held at the Fed paying minimal interest rates. Essentially, their net interest income (NII) was diluted in return for more profitable core lending. But which Eurozone bank, most of which are already struggling for any level of meaningful profitability, is going to sacrifice NII for a negative deposit rate at the ECB when they won’t be able to lend the released capital as there is no demand in Europe?
One could argue that monetary easing is needed while painful structural reforms are being carried out. But surely easing should follow reform, or at least accompany it? Otherwise governments, buoyed by bond-buying, can please voters, ignore fundamental problems, and start spending again.
The way markets have behaved suggests that a firm ECB QE announcement will have a positive effect on European equity markets. That might be the case, but it will be short-lived. It will soon become clear that QE in the Eurozone is even more inefficient than it has been elsewhere, and that Europe’s growth outlook rests on as yet lacking supply-side reform.
Wilfred Frost is anchor of CNBC’s Worldwide Exchange. Follow him on Twitter @WilfredFrost