Tuesday, January 20, 2015

Eurozone QE is fraught with difficulty | Unrestricted QE is priced into the Single Currency

Quantitative Easing (QE) seems to have been at least something of a success in both the US and the UK. Its outcome has been apparently less than stellar in Japan, but they are, nevertheless, prepared to persevere with it, in the Land of the Rising Sun.

All of the above economies have a structure that could be characterised as homogenous, with monetary policy functionality that is, in a real sense, centralised. This places them in contrast to the de-facto situation in the Euro zone, at least at this point in its development. While the European Central Bank (ECB) is independent of the constituent governments, it has on its governing council a representative from one particular country who is truly “primus inter pares”, or first among equals, in the most extreme meaning of the term.

Germany is very conscious of the value it derives from its membership of the Euro. The recent experience of Switzerland, in having to take drastic measures to maintain some kind of reasonable value for its currency in order to prevent it appreciating, on the back of safe haven status, to a level that is disastrous to its exports, is exactly the situation that Germany would find itself in if it still used the Deutschmark. On the other hand, Germany is still the locomotive of the Eurozone economy. This has made it very fearful of any circumstances where it might be required to pick up the tab for the shortcomings of any or all other Eurozone members.

And this is what has given rise to the latest fudge in the preparation for Eurozone Quantitative Easing – the proposal that if bonds are to be bought in order to implement it, that each country’s central bank will have to be responsible for its own bond purchases, thereby placing the associated risk with the individual countries rather than with the Eurozone as a whole. If this were to happen the risk will not be, as they say, mutualised.

The Irish Minister for Finance, Michael Noonan, has expressed his displeasure at this idea. According to the Irish Times, he did so at a conference in Dublin. The Times reporter wrote “Mr Noonan’s remarks received a cold response from ECB executive board member Benoît Cœuré, who was sitting beside him in the same panel”.

If the process is not handled centrally it is even hard to see how it will be successfully implemented. Will each country be given a quota? How will their activities in the purchasing of bonds be policed?

The effect on the Single Currency

The recent precipitate fall in the value of the Euro against all major counterparts (not just the Swissie), indicates that Forex traders the world over have priced in an announcement of the start of QE in the next ECB monetary policy statement, which takes place tomorrow, Thursday (Jan 22nd). For these traders, QE is QE, as implemented in Japan, the US and Britain. Any deviation in the manner of its operation, such as that outlined above, has high potential to lead to an unwinding of Euro short positions. This will have the effect of reversing the fall that has been underway. Such a reversal could be severe because it would be likely to take place in quick time.

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