Historic ECB Stimulus May Fall Short of Targets

Nigel Thomas
22 Jan, 2015
New York City

European Central Bank followed through its widely advertised and anticipated plan to provide additional stimulus. The latest plan from the central bank will acquire government bonds of as much as 60 billion euros a month till September 2016.

European Central Bank followed through its widely advertised and anticipated plan to provide additional stimulus. The latest plan from the central bank will acquire government bonds of as much as 60 billion euros a month till September 2016.

The details and the decision to acquire government bond plan are not as simple as the purchase programs in the U.K. and U.S. were.

ECB President Mario Draghi stressed that the central bank is a single monetary authority in the union but will work closely with national central banks to acquire bonds and will share in the risk.

The proportion of bond acquisition will reflect the stakes held by each country in the central bank and the purchase program will also have additional restrictions to meet legal requirements of the union.

ECB President Mario Draghi also said in a statement that the bank will limit the purchase of individual bond at 25% and limit to 33% of any country outstanding bonds and the ECB will not have a preferred bond holder status.

The central bank will also purchase bonds in the open market at prices determined by the market.

The decision also highlighted the struggle in the euro zone and it took nearly six weeks of intense negotiations to work out details of the agreement and over German bankers’ resistance.

The European Central Bank will share in risk with national country bank in the event of a default addressing the prime concern of German lawmakers and Bundesbank to prevent from transferring risks to wealthy countries in the union.

The central bank also said it will lower the rate it charges to bank for commercial loans to 0.05% from the current 0.15%.

After the announcement, the euro declined 0.6% to a new 10-year low to $1.154 with the expectations of a flood of new money in the financial system and will exporters.

The central bankers around world are engaged in competitive devaluation as the U.S., U.K., Japan and now the euro zone are struggling to revive the economic growth.

U.S. and U.K. bond programs have helped two economies to stabilize and created conditions for the economy to recover in large parts after the financial collapse in 2008 and 2009.

Bond yields in many euro zone declined to new lows and yields on 10-year government bonds fell further and Italian bond yield declined to 1.58% and yield for Spain bond eased to 1.42%.

Financial markets across the euro zone welcomed the widely anticipated move but indexes still managed to rise between 0.4% and 1.5% in the euro zone.

Draghi also clarified and said the central bank can acquire bonds of troubled countries like Greece abut stressed such purchases will be small and in line with its condition not to hold more than 33% of the outstanding bonds of each country.

He added, Greece has to implement the reforms it agreed at the time of bailout organized by three institutions and administered by the International Monetary Fund and the European Commission.

However, several economists worried that the bond purchase program may have come too late and the benefits of the program may not realized soon enough to lift economic growth in several countries in the euro zone.

Europe is battling structural issues ranging from diverging economic landscape, stiff competition from Asia, weak U.S. dollar and several countries in the euro zone facing double digit long term unemployment.