Monday, April 28, 2014

Is Euro zone QE off the agenda? | A stronger Euro

A press release from Standard and Poors yesterday highlights the stresses on the ECB in relation to the value of the Euro. In a diverse grouping of states, some of which are not even in the Euro zone, even if they are members of the Union, matters of economic and monetary policy are bound to be complex.

S&P’s economist, Sophie Tahiri, seems to have reached the conclusion that anything approaching Quantitative Easing (QE) in relation to the Euro is very much on the back burner at present. She does this by reference to the Euro Overnight Index Average (EONIA) and the spreads between 10 year German Bunds and U.S. Treasuries.

It is also true that while monetary easing might have an effect on deflationary pressures, which will be pushed back against by the Bundebank on the grounds that they hate inflation, it will do next to nothing for the real economy. Buying sovereign bonds will reduce yields, but as most businesses in Europe rely on bank lending rather than corporate bonds, unlike in the USA, a European style QE would do nothing for the small to medium sized businesses that are the backbone of European employment. A recent report in the Financial Times highlighted the fact that, even though ECB base rates now stand at 0.25%, bank borrowers in EU member states outside of Germany are forced to pay as much as 6% per annum for the privilege of taking on bank debt. That is, of course, if they can obtain it in the first place.

For all those reasons there is a growing consensus that even if the ECB is considering easing, it will not do anything to bring it on until the forthcoming European bank stress tests are completed, and that will be well on into 2014, if not at the end of the year. Tomorrow (Wednesday) sees the release of the Consumer Price Index in the Euro zone. A low reading here will make things more difficult for the ECB.

A stronger Euro

In recent times the Euro has shown remarkable resilience. A lowering of core interest rates by the ECB last year, threats of making the overnight deposit rate a negative figure and as much rhetoric for a reduction in the value of the Euro as could be mustered by various personalities in European economic circles have all been shrugged off by the market.

Theories abound as to why this should be the case. One that has surfaced recently is that the threat of sanctions on Russia has motivated that country to sell its US dollar holdings and convert them to Euros. There is also talk of a rebalancing of Chinese foreign reserves that serves to strengthen the Euro.

That may well be that case but the truth might be more mundane. Now that it has been established that the peripheral states, led by Greece, which were regarded as a risk to the whole Euro zone edifice a relatively short time ago, will be supported by the centre no matter what, their sovereign bonds represent particularly good value, with yields that exceed German bunds but which can now be seen almost as a proxy for them. In order to invest in the bonds of Euro member states, it is necessary to buy Euros. This, naturally, pushes up its value.

Conclusions about Euro QE being a non event should also tend to keep the Single Currency in an elevated state.

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