Extending QE in Europe? Draghi’s no hint

This week investors were anxious on the material news being expected, primarily the European Central Bank (ECB) rate decision, following the flow in chatter that the ECB will halt its quantitative easing (QE) program. As I had pointed out in my previous articles the said chatter had implied a sell-off of circa 350 basis points (bps) over the long-dated European Sovereign curve.

As expected by market participants, both QE and key interest rates remained unchanged. The market was more into the post-decision conference in which Draghi would possibly hint any possible future moves. The first bold statement by Draghi was that the QE program will be maintained until March 2017 and beyond if need be.

What prickled anxiousness in the Euro/Dollar was the comment from Draghi, whereby he stated that the QE program will not last forever. On the statement, the Euro reverted from a negative position of around 0.15 per cent to an intra-gain of 0.57 per cent. Let’s be realistic, why should the market react in such a manner, when in actual fact such statement is more than reality? From an economic perspective, long periods of monetary easing might create more harm to the economy than good. Personally I would be very concerned if the current fuelling of QE will be maintained for very long periods of time. This would imply that the economy hasn’t yet shown any moves of improvements.

An economic theory which in part might explain the possible harm effect of extended monetary easing is the ‘liquidity trap’ theory. Such theory states that consumers commence holding cash in their bank accounts, rather than investing, even though Central Banks are injecting money in the economy, through QE. Such behavior occurs due to the fact that consumers increased belief that the economy is heading towards a negative path. If the latter occurs this would imply that monetary stimulus is ineffective.

The market shift towards positivity occurred when Draghi assured those present that there was no discussion amongst committee members of when the trillion-euro bond buying program would be wound down. The euro depreciated to levels of 1.0926, while equity markets in Europe turned positive. Likewise as opposed to the recent sell-off within the sovereign curve, yields turned lower with the 15+ Sovereign curve recouping 37bps.

In my view, the latest chatter of halting the QE program might have been a diplomatic move in order to create more supply at higher yields to further accommodate the ECB. As I’ve pointed out few weeks ago, despite an improvement in economic data, numbers are still not accommodative enough to justify a tightening in policy. For instance, despite an improvement in inflation figures, one of the main mandates of any Central Bank, this is still way below its 2 per cent target level.

In my opinion, December’s ECB meeting should give the market some color of where the ECB is heading with its monetary measures. As being experienced by the current situation in the U.S. with regard to when the Federal Reserve should hike, now more than ever any move by the ECB is getting more data dependent.

As indicated yesterday by Draghi, despite there were no signs yet of a convincing upward trend in underlying inflation, expectations are that a pick-up is expected in the next few months.

Going forward the path towards the December meeting is still blurred. Lets not underestimate any hiccups along the way towards December’s meeting, primarily the Italian constitutional referendum which till date seems at dire straits.