We are starting to see green shoots in Europe. They include an emerging cyclical recovery in the Eurozone, aided by lower oil prices, the positive effects of austerity programs and structural reforms, and the removal of the immediate threat of Grexit. However, the real salvation for growth has been the ECB’s money printing effort, which has “incidentally” weakened the euro.
Five years after the Federal Reserve began its aggressive QE program in the US, Europe has experienced a weak economic recovery, made worse by falling consumer prices. Faced with the economic threat ECB President Mario Draghi launched a massive strategy to buy sovereign European bonds as part of a €1.1trn asset purchase program.
Yet Fed-style QE in Europe is unlikely to have the advertised effect. In Europe, companies are less likely to get funding from liquidating bonds rather than from going to banks for loans. In addition, the ECB’s decision to buy sovereign bonds in proportion to the size of its member nations’ economies means even more cash will push German and French yields still lower. Meanwhile, attempts to buy peripheral bonds from Greece and Spain is likely to create a moral hazard by bailing out wasteful, austerity-weary governments. And finally, since the return on capital in Europe is well below that of the US, QE cash is more likely to fuel asset bubbles instead of benefiting companies and households.
We suspect – aided by recent evidence of economic recovery in the US and Japan – that debasing the euro will provide a quick solution, and one that might support Greece and save the EU. Yet there is a dark side. Once countries are hooked on a weaker currency to drive growth, the ECB will have to keep QE going, regardless of German fears. The QE program should run till September 2016, but should inflation and growth remains subdued, expect the ECB will increase its monthly purchase volume to keep the EUR weak. Perhaps the only thing that can halt EUR downside is the Feds fear of a stronger USD.