The ECB is being stalked by the shadow of deflation
Photograph by Alessia Pierdomenico — Bloomberg via Getty Images
By Geoffrey Smith
October 2, 2014

The European Central Bank will start buying private-sector bonds later this month and carry on doing so for two years, President Mario Draghi said Thursday, but his promises disappointed financial markets that had been hoping for more.

Eurozone stocks sold off and the euro rose after Draghi’s monthly press conference ended without any real suggestion that the ECB is close to adding to the stimulus measures it announced last month, in order to support an economy that is sliding into recession and, as many fear, deflation. Annual inflation hit a five-year low of 0.3% in September, well short of the ECB’s target of just under 2%.

Towards the end of trading on the continent Thursday, the EuroStoxx 600 index was down 1.4%, while the euro was up nearly half a cent at $1.2647.

“Investors had hoped that the ECB would step-up stimulus plans after the recent weakness in both growth and inflation data, either by announcing a very large amount of purchases, or the addition of sovereign debt purchases,” said Azad Zangana, European economist at fund manager Schroders in London.

Instead, Zangana argued, Draghi dodged questions about how much money the ECB intends to pump into markets through its new channel, and was less forceful than before in claiming that he wanted to boost the ECB’s balance sheet back to the size it had two years ago.

In a frequently defensive tone, he pointed the finger at Eurozone governments for failing to do their part to revive growth by overhauling labor markets and cutting deficits. He added that the bank would take more, “unconventional” measures if needed to sustain a recovery that he said was “fragile, weak and uneven.”

Draghi had originally announced last month that the ECB would start buying asset-backed securities and covered bonds (a sort of European cousin of ABS), taking them off banks’ balance sheets so that they had the space and capacity to offer new loans to businesses and households.

Schroders’ Zangana and others said that the trouble with the plan is that there aren’t enough of such bonds on the market for the ECB to make a difference to the economy by buying them up. The bank will only buy senior and guaranteed ‘mezzanine’ tranches of ABS, that is, those parts of a bond which have preferential claims in the case of a default.

He made one important concession to Greece and Cyprus saying that the junk status of many of their ABS would be ignored as long as they remained in E.U/I.M.F.-sponsored bailout programs. Economists such as Germany’s Hans-Werner Sinn rail that that will turn the ECB into a dumping ground for toxic assets, a sort of ‘bad bank’ for the Eurozone, but it could also be unpopular in Greece, as it will deter the government of Prime Minister Antonis Samaras from escaping the suffocating embrace of its creditors ahead of time, as it wants to do to revive its popularity.

The ECB made no change to its interest rates this month, leaving the key refinancing rate at 0.05%. Draghi said last month that the ECB couldn’t effectively cut rates any lower.







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