ECB Executive Board's QE Proposal Calls for Roughly EUR 50Billion in Bond Buys Per Month

By Brian Blackstone 

        FRANKFURT--The European Central Bank's executive board proposed buying roughly EUR50 billion ($58 billion) a month in bonds for at least a year, according to people familiar with the matter, but markets largely shrugged as investors pondered whether the ECB will do enough to stoke Europe's fragile economy.
        The board's proposal for the bond-purchase program, known as quantitative easing or QE, forms the basis of deliberations by the entire 25-member governing council on Thursday on whether to embark on a path already forged by the U.S. and the U.K. but mostly avoided in Europe. The final number and details of the program could change after the full board has its say.
        The initial reaction to details of the ECB's plan in the financial markets on Wednesday was jumpy, betraying nerves among investors who have racked up large bets on aggressive action by the central bank. The euro fluctuated before ending the trading session in Europe a little lower, showing that traders and investors see the proposals as a sign that large asset purchases are coming, and there was a modest price decline in government bonds in the U.S. and the eurozone. Stocks rallied after an initially volatile reaction, with Germany's DAX index closing at around an all-time high.
        Despite those gains, the markets showed a less-than-dramatic response, signaling that expectations for more easy-money policies from the ECB are already factored into stock, bond and currency prices.
        Investors are counting on the ECB to unveil a program that will shock and awe the market, said Christopher Sullivan, who oversees $2.45 billion as chief investment officer at the United Nations Federal Credit Union in New York. But "from what we have seen today, it seems investors are anything but confident they should expect that outcome."
        "More details are needed from [Thursday's] official announcement" and ECB President Mario Draghi's news conference, said James Kwok, head of currency management at Amundi Asset Management, which manages $1 trillion.
        The lack of a stronger market response also reflects the success the ECB has had in recent months in convincing investors that they were prepared to act. In that sense, the bank has gotten many of the effects of QE--lower bond yields and a weaker exchange rate--before actually launching the program.
        One key unknown detail is whether the bond purchases will be spread across central banks in the eurozone, which is the norm for monetary-policy operations, or if the ECB makes an exception and puts the risk for each countries' bonds on their national central bank, meaning Germany's Bundesbank would hold German bonds and France's central bank would assume the risk of French debt. That approach could assuage concerns in Germany that its taxpayers may be on the hook for other eurozone members' debts.
        Still, the initial outlines of the bond-buying proposal highlight how aggressively the ECB thinks it needs to act to restore prosperity in the 19-member eurozone, which has failed to fully recover from the global financial crisis more than six years ago. Consumer prices fell 0.2% in December on an annual basis in the currency bloc, well below the ECB's target of inflation rates just under 2%, raising the risk of a lengthy and debilitating string of price drops. The unemployment rate was 11.5% in November, far higher than in the U.S. and U.K.
        "The ECB decision is very important for my country, but decisive and crucial for the European economy," Italian Prime Minister Matteo Renzi said in an interview with The Wall Street Journal, adding that it is "absolutely important in the future to give more power to the ECB."
        In another instance of central bank action in response to the slowing world economy, Canada's central bank on Wednesday delivered a shock interest-rate cut--its first since April 2009--citing low oil prices.
        The ECB's next step is part of a broader challenge it faces shaping the expectations of investors, businesses and households about the future.
        Economists have long believed that policy makers influence markets and economic activity not just through formal channels like credit or stock markets but also by shaping the public's views about the future. For example, if businesses don't expect much economic activity, or if they expect low inflation to weigh on their profit margins, they will be less inclined to borrow or invest.
        If the ECB were to limit the program to EUR600 billion over one year, its attempt to jolt expectations will be "woefully inadequate," said Athanasios Orphanides, a professor at the Massachusetts Institute of Technology and former head of the central bank of euro-member Cyprus, who has been calling for a EUR2 trillion program.
        He said the potentially open-ended nature of the program--the idea the ECB could continue beyond a year--is a bright spot that could give the program additional power. "The Fed's QE3 program worked very well in the United States because it was open-ended," he said.
        ECB officials have sent strong signals in recent weeks that they are prepared to launch large-scale buying of government bonds, known as quantitative easing, at their Thursday meeting. With official interest rates near zero and ample loans to banks showing little effect on inflation so far, the ECB is left with few options apart from buying bonds in the public debt market with newly created money, thus raising the money supply.
        Other major central banks including the Federal Reserve, Bank of England and Bank of Japan relied heavily on quantitative easing to reduce long-term interest rates in the aftermath of the financial crisis. But the ECB has largely refrained from this measure in recent years, relying instead on interest-rate cuts and loans to banks as a means of steering new credit to the economy.
        Although buying bonds appears to have broad support in the ECB's governing council, the bank's two officials from Germany have signaled they are likely to oppose the measure. Quantitative easing is deeply unpopular in Germany, where it stirs fears of inflation and the use of central bank money-printing presses to finance wasteful government spending.
        "I am currently not convinced by large-scale purchases of government bonds," ECB executive board member Sabine Lautenschläger said in a German magazine interview published Jan. 10.
        And many analysts doubt whether quantitative easing, even on the large scale the ECB board proposal suggests, would work in Europe's fragmented economy, where 19 different bond markets have varying degrees of riskiness.
        Although the prospect of a flood of ECB-printed money has boosted stocks and bonds, it may not do much to stimulate stagnant economies in France and Italy, for instance, where unemployment is high amid unreformed labor markets.
        "There are still reasons to doubt that QE, no matter what its size, is going to change the outlook for the euro area," said Jonathan Loynes, economist at consultancy Capital Economics.
        Jon Hilsenrath,
        Katie Martin
        and Min Zeng contributed to this article.
        Write to Brian Blackstone at brian.blackstone@wsj.com
        (END) Dow Jones Newswires

        January 21, 2015 19:30 ET (00:30 GMT)

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