The European Central Bank (ECB) shocked capital markets yesterday by lowering its overnight rate, marginal lending facility, and deposit facility on Thursday. This led to a steep decline in the Euro against the U.S. dollar of 2%, a huge move for currency markets. ECB president Mario Draghi announced the ECB would begin purchases of asset-backed securities and Euro-denominated bonds, also known as a form of QE (Quantitative Easing), finally joining the likes of the U.S., U.K., and Japan.
Let’s check in on some data to see how Europe is doing since it dominated headlines in 2011-12.
The risk of QE causing an inflation breakout is low, considering Euro Area inflation is below 1%.
Compared to the world, the Euro area, including Germany and Greece, shows varying degrees of contraction in bank lending. This is not a healthy situation.
With little lending going on, it is tough for businesses to invest and in turn hire people. Unemployment rates across the Eurozone are elevated, especially Spain and Greece.
With Japan implementing QE for the first time in 1997, we turn the yields back 17 years for the U.S. and Germany. Doing so puts the correlation of Germany’s 10-year yield with Japan’s yields at 0.9 and 0.7 for the U.S. Avoiding a deflationary trap should be the number one priority for Euro policy makers.
It was good to see Mario Draghi acknowledge that monetary stimulus can only do so much to stimulate the economy and that fiscal measures will need to be taken (such as tax cuts), a nod to Germany’s current austerity programs affecting the rest of the Eurozone. Just as Richard Koo, Chief Economist at Nomura, demonstrated in his book, The Holy Grail of Macroeconomics, quantitative easing (QE) is “the great monetary non-event,” as it relates to the real economy (not necessarily financial assets) as he found in his study of Japan and the U.S. in the Great Depression. The European banking system at some point will need to recognize the game of musical chairs it has played with marking assets at higher values than they are worth, but then, that is kind of the point of the charade.
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