Quantitative easing in the Euro area

Transcription

1 Quantitative easing in the Euro area Rationale, impact and some considerations for Malta 11 February 2015

2 Rationale for quantitative easing Quantitative easing (QE) refers to the purchase of government bonds (and other assets), intended to inject liquidity directly into the economy, without relying on the banks willingness to borrow from the ECB and lend. The Governing Council of the ECB launched this programme in order to counter the threat of deflation. Deflation has various negative effects, including: The real interest rate rises:this is defined as the money rate of interest minus the rate of inflation. With deflation, the latter becomes negative and thus pushes up the real interest rate. Thus monetary policy becomes less accommodative for growth. Precisely the opposite of what is currently required. 1

3 The impact of deflation (1) The burden of debt: Deflation inflates the real value of debt. As prices fall the burden of debt increases. With higher real rates of interest, servicing the debt becomes more costly in real terms, leading to lower investment and lower consumption. Consumption: Deflation reinforces a decrease in spending: households tend to hold off on their own spending knowing that prices are likely to be lower tomorrow. Investment: Companies tend to delay their investments since higher production in the future (financed by their investment today) would be sold at falling prices which is likely to squeeze profits. 2

4 The impact of deflation (2) Second-round impact of falling prices: As prices fall, inventories become more expensive to hold. This reduces demand for goods thereby slowing the economy further. Expectations: As deflation or very low inflation persists, the expected level of inflation may change. This de-anchoring of inflation expectations makes it difficult for Central Banks to steer the economy towards the 2% target which is today judged by all Central Banks to be an appropriate rate to support economic growth. Conclusion: As all the above effects work their way through the economy, there is a danger that an economy enters a long period of low growth and stagnation, moving away from its potential output, combined with persistently very low inflation or deflation. 3

5 Monetary policy already adopted by the ECB The ECB has used various conventionaland unconventionalmonetary policy instruments in order to spur economic activity, such as: Conventional instruments: Short term interest rates lowered to almost zero. Forward guidance, especially to influence long term interest rates. Unconventional instruments: Purchase programmes for asset backed securities (ABS) and covered bonds (CBPP3). Longer-term funding to banks for new business loans (TLTROs). Results: The quantity of liquidity injected in the economy was below expectations partly because of the low take-up of TLTROs by the banks. The monetary stimulus was not sufficient. 4

6 Transmission channels of quantitative easing (1) Portfolio re-balancing: Increased demand for financial assets by central banks will push up their prices, reducing yields. This will create a rebalancing of the portfolio across the whole spectrum of assets. Policy signalling and confidence: By announcing large-scale asset purchases, central banks provide information about the likely path of future monetary policies to market participants. Bank lending:qe increases the volume of banks liquid reserves (when they sell their holdings of sovereign bonds). To restore equilibrium in their asset portfolios, banks are likely to offer a higher volume of loans to their clients. This channel also depends on demand for loans. 5

7 Transmission channels of quantitative easing (2) Market liquidity: QE increases liquidity in the economy, thus reducing the yields paid for liquidity or safe-haven purposes. In some cases, there are negative yields (such as the case of less than 5-year Bunds and some short term corporate bonds). This may stimulate further issuance of corporate bonds. Exchange rate: QE can lead to increased outflow of liquidity from the Euro zone, in search of higher yields elsewhere, and may hence reduce the price of the currency. A depreciating currency improves price competitiveness and helps net exports. It also counteracts the impact of low inflation or deflation, since the cost of imports from outside the Euro zone is likely to increase. 6

8 Euro depreciation against the USD and the GBP 7

9 Transmission channels of quantative easing Confidence Asset purchases Policy signalling Portfolio rebalancing Market liquidity Asset prices rise and the exchange rate depreciates Total Wealth rises Cost of borrowing declines Higher Spending and Investment Positive Impact on inflation (Target 2%) Money Bank lending rises Source: Adapted from Royal Bank of Scotland 8

10 Modalities of quantitative easing (1) Size of the programme: Each month, the ECB will buy 60 billion in financial assets, including asset-backed securities, covered bonds, bonds issued by Euro area central governments, agencies and European institutions.ecb s QE represents 7% of Euro area GDP, as compared to Bank of England s QE, which amounted to 20% of the UK s GDP. National size: The CBM s share in the public securities purchases would be around 36 million per month, between March 2015 and September Duration: March 2015-September 2016 [or until we see a sustained adjustment in the path of inflation which is consistent with our aim of achieving inflation rates below, but close to, 2% over the medium term Draghi, 2015]. 9

11 Modalities of quantitative easing (2) Purchases: NCBs: 92% of QE purchases ECB: 8% of QE purchases Risk sharing with other NCBs: 20% of QE purchases will be subject to risk sharing. Prices: QE would probably drive up the prices of bonds by increasing demand, which causes their yields to fall. Lower yields, in turn, provide the fuel for economic expansion by reducing borrowers costs. In December 2014, the ten-year government bond yields in Malta were at 1.94%, as compared to 0.59% in Germany. 10

12 Some considerations of quantitative easing for Malta Central Bank of Maltawill purchase Maltese government securities and hold them for the Eurosystem in a separate account. Consumers are subject to two effects: (1) Interest rate effect lower lending rates induce more spending (2) Wealth effect the value of assets is set to increase since demand for assets is higher. Asset prices (including the property market): Part of the funds may be redirected into the property market, leading perhaps to an expansion of the construction sector. The property market may eventually benefit from QE. However, supervisory authorities should ensure that there is no risk of an asset bubble. Macro prudential policies may be necessary. Financial institutions: Maltese financial institutions hold a relatively large amount of MGS s. Selling their MGS holdings will provide an opportunity to further diversify their assets and to be less exposed to government debt. 11

13 Quantitative easing in the Euro area as compared to other regions Bond yields in the Euro area are already very low (negative in some cases), as compared to the US yields at the start of the Federal Reserve s QE. Compared to the US and UK, Europe is characterized by: i. Predominance of bank financing as against capital market funding for corporate investment ii. Relatively large holdings of sovereign bonds by banks This makes the effectiveness of QE in Europe more dependent on the bank lending channel. However, QE allows the ECB to expand its holdings of assets, thereby absorbing some of the risks in the Eurozone economy through this expansion of its balance sheet. As lending costs decline, governmentsmay be tempted to delay structural reforms. However, without structural reforms in say Italy and France, growth in the Euro zone may remain anemic. 12

14 Malta s 10-year bond yieldscompared to non-stressed countries 13

15 Malta s10-yearbond yields compared to stressed countries 14

16 Euro area 10-year government bond yield spreads 15

17 MGSs held by category 16

18 Price and YTM of the latest MGS issue 17

19 Thank you