The ECB should not extend its bond purchases

Speeches and releases from various European Central Bank officials don’t make the best summer reading, that’s for sure. But it might be a good idea to go through a couple of recent ones, which give a hint of what the future might bring.

The ECB’s plans for the fate of its asset purchasing programme are clear: the central bank will halve its purchases of bonds in September and stop them altogether in December.

Looking at some of the data, it is obvious why the central bank wants to end its quantitative easing programme. While it did help to bring yields on the bonds of the eurozone’s periphery countries down and avert a credit crisis, the programme is running out of steam.

Its stated purpose was to encourage (or, some would say, “force”) people and businesses in the euro area to save less and consume more, and thus support the economy. But the latest statistics show that the savings rate is in fact increasing.

In the year up to the first quarter, savings by eurozone households, corporations and the government increased to 8.5% of net disposable income, versus 7.9% a year ago. Non-financial investment increased as well, to 4.3% of net disposable income from 3.8% a year ago.

However, a comparison between these two indicators shows that savings have grown at a faster, albeit unequal pace than investment, despite the ECB’s financial repression.

Since the fourth quarter of 2012 (when the effects of Mario Draghi’s now famous “whatever it takes” statement begun to made themselves felt) to the first quarter of this year, savings in the eurozone have increased constantly, as the chart below shows.

Savings in the eurozone since 2012. Data source: ECB, Eurostat

Non-financial investment also increased, but at a much slower pace.

Investment in the eurozone since 2012. Data source: ECB, Eurostat.

What this means is that the ECB’s extraordinary monetary policy easing has reached its useful life. Real and even, in some case, nominal negative interest rates did not discourage eurozone individuals and corporations from saving.

In fact, just the opposite seems to be true: the more interest rates fell and the more quantitative easing the ECB carried out, the more savings increased. This could simply be a sign that people just tried to compensate for lower interest rates by saving more – which defeats the whole purpose of the policy.

Having finally realized this, the central bank is orchestrating its slow retreat from the capital markets. Accustomed to ever-lower interest rates, an army of young traders have no experience of monetary tightening. A recent speech by Sabine Lautenschläger, Member of the Executive Board of the ECB, warns us about what is ahead.

While promising that the central bank will move at snail’s pace with tightening and reminding us that even when asset purchases stop, there is still the stock of bonds already bought, she added: “A first hike around the middle of 2019 is not entirely out of the ballpark.”

That is not unexpected. Markets are already pricing that in. However, the most important part of her speech is the one about the future of quantitative easing measures.

Having seen the success of Mario Draghi’s QE, many people are now suggesting that asset purchases should become the norm among monetary policy tools for the ECB – like they have been in some emerging markets for quite a while.

But Lautenschläger disagrees. “Let me say clearly that I think this should not happen. The short-term benefits should not lead us to overlook the long-term costs and the severe side effects. These costs and side effects can be quite high, and they tend to grow over time,” she said.

She cites three main ones. The first is moral hazard. If people can be sure that interest rates will stay in real negative territory forever, there is every incentive to borrow and spend money they don’t have.

The second is financial stability. The major central banks’ asset purchases have inflated asset price bubbles, not least in the housing sector. Lautenschläger recognised this, although she put it more diplomatically.

“When the central bank buys bonds, it might also fuel asset price bubbles, financed by cheap credit. This risk increases the longer unconventional monetary policy measures continue to be applied,” she said.

Lautenschläger saved the most important for last. “And  third, monetary  policy  can  only  buy  time — no  matter  how  loose  or  unconventional  it becomes. Monetary policy is not a tool meant to alter the long-term viability of economies, and it would be dangerous to believe otherwise.”

After a long party for which the ECB paid the bill, the eurozone economies will soon find themselves on their own again. Hopefully, they have not forgotten how to cope.