Wolfgang Munchau in Monday's FT describes how he believes central bankers talk too much and act too little. To no real surprise he is referring to the ECB in particular. He expresses the view that the ECB will eventually have to introduce quantitative easing (QE), but is questioning why it has not yet done so. In his view, QE is the only effective big policy tool to lift inflationary expectations. Today's eurozone inflation data continues to show that whilst the eurozone economy as a whole is not experiencing deflation, it's getting jolly close.
Wolfgang Munchau asks the question, why when the ECB declares there are no legal obstacles to negative interest rates or quantitative easing it does nothing but talk? Some analysts make the point there may not be legal impediments, but there are political ones. The most obvious one is that the German courts have deferred to the EU to decide on the legality of the outright monetary transaction initiative, which is a mechanism created by the ECB to allow it to buy assets in the open market.
Our view is that the ECB has only acted in the past when it is left with absolutely no choice, and this time will be no exception. Despite the increased threat of deflation raising the value of debt within the eurozone, peripheral bond yields continue to fall.
Post today's inflation data, peripheral bond yields have fallen to multi-year lows. Greek 10-year bonds that once offered a yield of close to 40%, are now trading with a yield below 7%. This is despite the possibility that, as some analysts believe, Greece may need a third bailout.
At present the ECB has no need to act, it will only feel the need to do so, as it has done in the past, when and if peripheral bond yields start to rise once again. When the US Federal Reserve began tapering the bond purchase program, money was withdrawn from emerging markets, as speculators looked to repatriate dollars. We were surprised that peripheral yields did not fall victim to a similar fate. One can only conclude the ECB's implicit guarantee continues to hold good with investors.
We have argued on more than one occasion that the ECB will be forced one day to introduce some form of QE, and that this will probably coincide with the Federal Reserve tapering in its monetary stimulus. We have seen the start of the Fed tapering and increased speculation that the ECB will act, but so far it has resisted the temptation. Today's eurozone inflation figure of 0.5% will increase speculation that the ECB will move on Thursday. Our view is that we expect more of what we have seen from Mario Draghi and the ECB in the past weeks: more talk and less action (sadly for Mr Munchau) at least until peripheral bond yields start to rise again.