Beyond Bulls & Bears

European QE: Has It Been Worth the Effort?

Despite unprecedented accommodative monetary policy, including near-record-low interest rates and a massive asset-buying programme, the eurozone’s economy is languishing. Exports are slowing and inflation is hovering below 0%.1 Some observers are now questioning the European Central Bank’s (ECB’s) strategy and asking whether its quantitative easing policy can be effective. David Zahn, head of European Fixed Income, Franklin Templeton Fixed Income Group, backs the ECB’s approach so far, but thinks a further shot in the arm is needed—and quickly.

David Zahn
David Zahn

David Zahn, CFA, FRM
Head of European Fixed Income
Senior Vice President
Franklin Templeton Fixed Income Group

Just over six months into the European Central Bank’s (ECB’s) quantitative easing (QE) programme and nine months after it was officially announced, it is tempting to look at the results and ask whether it has been worth the effort.

Although inflation continues to hover below the 0% mark—significantly below the ECB’s 2% target—and the euro exchange rate is largely unchanged versus the US dollar from six months ago,2 we think the programme has been important in getting the eurozone back on track. However, we recognise that further action will likely be required and expect the ECB to announce further accommodative measures, possibly as early as this month’s Governing Council meeting on October 22.

In recent months, Europe has largely been spared much of the volatility afflicting global markets, but it is likely to feel the knock-on effect of sluggish global growth forecasts this year.

As a result, the eurozone export machine for this year and next year likely won’t be as robust as the depreciation of the exchange rate might have led observers to expect. The evidence of that is starting to show through in data such as German export figures for August, which were down 5.2% month-on-month.3

We don’t think exports from the eurozone are going to collapse, but we do recognise a slowdown is likely. As a result, we expect the ECB to take further action. However, we think the central bank has done as much as it can on interest rate levels and hold the view that cutting rates further in Europe would not help spur growth and inflation. Rather, we believe the ECB should be looking to adapt its QE programme to inject liquidity. Specifically, we think the ECB should be looking to extend QE past its current September 2016 deadline.

We consider the other option—increasing the size of purchases per month—would be more problematic both politically and practically. For example, assuming the ECB intends to maintain its policy of buying assets on a pro-rata basis for all countries, it could quickly run out of German government bonds, also known as Bunds, to buy should it increase the monthly purchases.

Looking at the headline metrics since the current QE programme came into effect may prompt investors to ask whether it has been as effective as the proponents hoped. We have not, for example, seen as much impact on the strength of the euro as many observers were expecting, nor have exports grown as substantially as many anticipated.

However, we think the outcome so far is partially down to the large current account surplus that Europe runs. That surplus may mean the euro remaining relatively range-bound in the foreseeable future. It’s difficult for us to see the euro declining substantially. So, prospects of an export boost to eurozone growth look reduced.

In considering the efficacy of the ECB’s approach, we think it’s also important to look back to the lead-up to the QE announcement and to remember the programme had been flagged well before the actual implementation. Between June 2014 and January 2015 when the programme was formally unveiled, we saw a 20% depreciation in the euro,4 largely, we think, in anticipation of QE coming into play.

1015_Euro_Account_2

1015_Euro_strength

Another area where QE has been effective, we think, is in encouraging bank lending, particularly in periphery eurozone countries. Lending rates have come down and loan demand has started to show signs of an uptick,5 so we recognise that QE has lowered the exchange rate from where it was before the programme was introduced and has eased lending conditions as well. Both of these factors have been positive for the eurozone economy.

1015_Euro_Loans

Now, we feel the time is right for a further shot in the arm. In our view, it’s not a question of whether the ECB will extend QE, it’s a question of when: Will the announcement come in October or December? Few ECB watchers are expecting an announcement this month, so any change at this time could produce a bigger impact because it is relatively unexpected. The general feeling, however, is that the ECB is more likely to act in December.

The comments, opinions and analyses are the personal views expressed by the investment manager and are intended to be for informational purposes and general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The information provided in this material is rendered as at publication date and may change without notice, and it is not intended as a complete analysis of every material fact regarding any country, region, market or investment.

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1. Source: Eurostat, September 2015
2. Source: Bloomberg
3. Source: Statistisches Bundesamt, October 2015
4. Source: European Central Bank
5. Source: European Central Bank Lending Survey, 2Q2015