Deflation fears in Europe as the ECB contemplates asset buying program

Ambrose Evans Pritchard writing in the Telegraph:

A key gauge of deflation risk in Europe is flashing red, dropping to record lows on fears of fresh recession and lack of decisive action by the European Central Bank.

The sudden lurch downwards came as Bank of America warned that France’s debt ratio could rocket to 120pc of GDP within five years, unless the EU authorities take radical steps to reflate the region’s economy. Italy’s debt could threaten 150pc even earlier.

The 5-year/5-year forward swap rate monitored closely by traders plummeted beneath 1.77pc on Friday morning as a global growth scare drove European stock markets to a 12-month low.

“This rate is the most important market signal on the planet right now. Everybody is watching the chart, and it has just gone off a cliff,” said Andrew Roberts, credit chief at RBS.


The US Federal Reserve, the Bank of Japan and the Bank of England all set clear timetables, spelling out exactly how many bonds they would buy, and the scale has been much larger in proportion to GDP. The ECB has merely given pledges, and these have since been qualified by the Bank of France, and have been openly attacked by the Bundesbank.

Germany’s five economic institutes - or Wise Men - said the ECB’s asset purchases will add “hardly any” extra stimulus to the real economy and may be unworkable in any case. They said there are not enough private securities that can plausibly be bought, and noted that a previous scheme to buy €40bn of covered bonds had run into the ground.

Part of the problem is the ECB itself. It's not really a central bank as the Federal Reserve or the Bank of England is. The European Central Bank is actually 11 central banks in one, each bank responsible to its own government. This means that policy making on a continental scale is very difficult. And the kind of radical measures Draghi is contemplating to reinflate euro-economies might not even pass the board.

It's not even clear its asset buying plan is legal. A German court ruled that the backstop plan for Italian bonds "manifestly violates" the EU treaties and would probably prevent the Bundesbank from participating in any asset or bond purchases. Without German participation, any ECB plan would fail.

We've heard this talk of disaster before. What will probably happen is that the ECB and EU countries will do just enough to kick the can down the road a few months or years, hoping things will change on their own. There's just no way they will address the underlying problems that threaten economic stability.





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