Draghi Remains Bullish on QE

The European Central Bank remains committed to expanding the euro monetary base, as its president affirms its policy is improving European economies.

The European Central Bank remains committed to expanding the euro monetary base, as its president affirms its policy is improving European economies.

ECB President Mario Draghi said in a statement Wednesday that there was “clear evidence” its controversial quantitative easing program was working, hinting that criticism from the Bundesbank and doubts from Germany policymakers that deflation was a real concern were unwarranted. Thought controversial, the QE program has received broad global support from as far afield as the President of the United States and the Prime Minister of Greece.

At the same time, German policymakers have repeatedly cautioned that the bond-buying program would be inflationary and dangerous, while also insisting that Greek debt remains outside of the purchasing program. The recently elected Syriza party has suggested adding Greek debt to the program, which in turn could help the country continue to repay its debts and maintain a budget surplus while giving greater investor confidence in the country’s solvency.

High Inflation Unlikely

“We expect the economic recovery to broaden and strengthen gradually,” Draghi said, adding that criticism that the program would be too inflationary too quickly was unwarranted.  “I’m quite surprised frankly by the attention that the possible early exit of the program receives when we’ve been in this program for only a month,” he said.

Several market indicators suggest that, rather than inflation, deflation still threatens the Eurozone. Germany’s 10-year bond yields fell to its lowest rate in history, and yields remain negative for five-year and shorter-term bonds.

A recent report on consumer prices also showed a disinflationary trend. In March, the Eurozone consumer price index rose to -0.1% annual growth. While higher than the -0.3% rate in February, two consecutive months of price declines could indicate a deflationary trend that could yield a liquidity trap.

Some economists, particular in the Bundesbank, dismiss these worries, emphasizing the role falling oil prices have had on price declines. If lower energy costs are driving the fall in prices, this trend could be stimulative and encourage more consumer discretionary spending. Evidence of that development has so far been meager.

A Brake on Rates

In light of continued negative price growth and low yields throughout Europe, the ECB announced it would keep interest rates unchanged while continuing its 1.1 trillion euro bond-buying program. Modeled somewhat on the bond-buying program the Federal Reserve initiated in 2012 and 2013, the ECB’s plan is designed to encourage more investment in the economy and stimulate growth. Its effectiveness has remained somewhat controversial, although some economists argue it is too early to judge the ECB’s plan.

The program has encouraged more investment in European equities, driving double-digit gains year-to-date for German and French stock indices. Some analysts believe more gains are coming, while Goldman Sachs, Barclays, Nomura, and Morgan Stanley have released notes to investors encouraging allocations in European equities.