It is expected that the European Central Bank will introduce Quantitative Easing within the Euro zone during its policy meeting set to be held on January 22, 2015.
European Central Bank Set To Implement Quantitative Easing, Effects Still Unknown
This move, coupled with the withdrawal of the cap on the Swiss franc against the euro could see far reaching effects in the region.
Market observers are expecting that the ECB will propose that national central banks in the region buy out up to €500 billion or $575 billion in sovereign debt. This could be either an open-ended purchase or a defined initiative that places a limit on the amount of debt that could be possibly bought.
The ECB is keen on placing the responsibility of purchasing the sovereign debt solely on national central banks. This move is set to allay fears that taxpayers will carry the burden in the event that one or more countries default.
National banks will purchase their own government’s debt according to how big their economy is, with the ECB providing the cash to buy these debts.
An impending deflation in the Eurozone
The main reason why the ECB is keen on implementing quantitative easing (QE) measures is the fact that the euro zone risks entering into deflation, if it hasn’t yet.
According to the ECB, deflation is generally defined as a decline in the prices of goods, services and commodities. As a result, consumers slow down their consumption patterns as they anticipate that prices will further decline. Without a doubt, the Euro zone is facing slow growth and initial signs of a deflation are eminent. The QE measures are geared toward accelerating inflation and domestic growth.
In particular, the ECB is looking to increase the circulation of cash now that interest rates are at zero. The bank’s balance sheet has steadily been growing smaller after commercial banks halted their spending spree to stabilize their own balance sheets.
Repercussions of a default
If one or more countries default, the effects will be felt far and wide through the euro zone. In a sense, the currency that is printed to purchase the sovereign debts would still be available even if the debts were no longer available.
It is certainly possible for a government to default but still live up to their promise to fulfill the debts held by their central banks by acquiring new default obligations. Market observers note that whether or not governments default, the implementation of the QE will need to go on to save the euro zone from massive economic repercussions.
The QE is seen as a last resort measure to solve the problems facing the zone. What is unclear though is whether the program will actually work. It is anticipated that QE will reduce the yields of stable assets such as government bonds. This in turn would boost demand among investors to purchase riskier assets to trigger economic growth. The problem though is that government bonds are presently lower than they have been in a long while.
Market impact of the Quantitative Easing
· The ECB’s decision to implement QE will likely make the Euro weaker than it is already.
· Economists also warn that the QE could create extensive market volatility akin to the instability witnessed when the Swiss National Bank withdrew its currency peg.
· Investors will be happy to purchase the risky government bonds but most of this cash will likely not circulate in the euro zone economy as investors look to invest elsewhere, primarily in real estate.
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