Analysis: Success of QE is an open question

There is no doubt that the ECB announcement is a significant change of policy, brought about by the risk of Europe slipping into a prolonged period of deflation. The amount of money involved is enormous - over €1 trillion will be spent by the ECB and its member central banks buying government bonds up to September of next year, with possibly more to come after that.

The US Fed and the Bank of England may have both done the same, but unleashing QE is still a massive and unorthodox gamble. In the US, former Fed chairman Ben Bernanke once said that QE “ worked in practice, but not in theory.” In other words it seemed to help revive the US economy but nobody was quite sure of how it worked.

Whether QE will now be enough to revive the euro zone and reignite inflation is an open question. Ideally, the QE move would have come earlier and would have been accompanied by fiscal expansion in the richer, central EU states. However given the trends in inflation, with consumer prices dropping 0.2 per cent year on year in December, the ECB was finally spurred into action, with Draghi pushing ahead against German opposition.

Concessions

There were some concessions to Germany, including planning that national central banks, and not the ECB, would hold most of the bonds and thus - Draghi said - take the risk caused by falling prices in future or even a sovereign default. Many economists argue that this spreading of risk is more apparent than real, given the nature of bank balance sheets and the options open to governments to recapitalise central banks, if this were ever needed. However the political and market reaction to this may still be framed by the fear that the richer member states are baulking at the kind of risk-sharing normal for a single currency area.

The ECB cleverly managed expectations, ensuring that the size of the programme was a bit more than the markets had expected. The initial reaction was positive, with the euro falling and European shares rising. However it is the reaction in the months ahead that will matter. Weak growth and monetary expansion should keep interest rates low and the euro weak - which will help.

It may also support stockmarkets and other markets for assets such as property. QE has faced some criticism for boosting asset prices, helping the better off and inflating bubbles, but in the current environment central banks will feel they have little option.

Questions remain

Whether the ECB programme can really encourage banks to lend more by giving them more cash is open to question. The euro banking system is still damaged and in any case the main problem is not the lack of supply of credit, it is lack of demand from consumers and businesses. For this reasons it is also important that QE is seen to boost confidence and spending across the euro zone economy.

For Ireland the biggest impact would come if the programme helped to spur confidence and growth in Europe, one of our biggest export markets. A lower euro would also help exporters selling outside the euro zone. The Republic would also welcome an uplift in the rate of inflation, as this is important to help gradually reduce the burden of our national debt.

The programme should also support Irish government bond prices, which rose today in response, pushing their yield under 1.2 per cent. Details are awaited of exactly how many Irish government bonds the Central Bank will purchase, though on the basis of the announcement it could be up to €10 billion over the next year and a half. If bond interest rates remain low, then the government will be able to raise new borrowings cheaply, benefiting the exchequer.

Will this send new money flooding into the Irish economy? Only if demand for loans increases to meet any new supply. Some lowering of retail interest rates may help bolster this demand. But increased confidence and a continuation of growth and job creation would be even more important.