To QE or not to QE? That is the question. The European Central Bank made it clear it would seek a new tool to contain eurozone sovereign spreads at its emergency meeting last week. Rising inflation and the promise of higher interest rates are just two hurdles in the way of a new quantitative easing programme and the continuation of the “Draghi put” on European debt.
So far the market is playing along. Yields on Italian debt are back below levels that caused panic. But as the ECB forges ahead with its first rate rise in more than a decade, pressure on peripheral debt will resume. It will mean tightening via rate rises while selectively loosening to prevent “fragmentation”. To be successful, the next step in the European monetary and political experiment has to be more radical than the last.
What the ECB will do is reinvest in existing maturities from its pandemic emergency purchase programme (PEPP). At about €15bn-€20bn monthly this would fall well below historic bond buying of up to €80bn monthly. It could choose to do the same with the public sector purchase programme maturities (PSPP), which would roughly double monthly purchases.
Another option would be to sell down holdings of core German and French sovereign bonds and buy peripheral debt.
Critics would point this out as a further step in the direction of monetary financing of government deficits. It would be open to legal challenge.
Sterilisation of bond buying could also be tried, where counter measures offset any expansion in the money supply. Higher deposit requirements were used to do this in the relatively small securities markets programme in 2010.
What the market really wants is another “whatever it takes” moment, invoking Mario Draghi’s 2012 commitment to preserve the euro. Underpinning that were outright monetary transactions, a bottomless bond-buying programme that shored up confidence in the euro without ever having to be used.
ECB dithering only serves to extend the amount of time — and the pain — before a new bazooka becomes inevitable.