The European Central Bank (ECB) is planning to pump at least €1.1 trillion into the troubled Eurozone economy.
This is huge economic news and will have a big impact on global investment markets.
European Central Bank president Mario Draghi made the announcement yesterday afternoon, after leaking the intention to markets on Wednesday.
What was leaked was a bit of a test balloon, suggesting an injection of €50bn a month.
What was announced yesterday was €60bn euros a month until at least the end of September 2016, possibly longer.
To put this in context, €1.1 trillion euros is £842bn Sterling $1.27 trillion US dollars. It’s an awful lot of money.
This is money which will be artificially created by the ECB and then used to buy a variety of government bonds which are currently owned by financial institutions, including banks and insurance companies.
Doing this reduces the interest rates on government bonds, because demand for them becomes greater, and hopefully results in more borrowing, because debt is cheaper.
More borrowing means people and businesses spend more money, and this boosts the economy.
This process is called quantitative easing, or QE, and we’ve already had it here in the UK. It’s also been used in the US and Japan, following the global financial crisis in 2007 and 2008.
We know the eurozone economy is really struggling. They’ve been battling a sovereign debt crisis for years, never really dealing with it, just deferring the problem with a few bailouts and financial assistance programmes.
This new measure was hinted at least year and called a ‘big bazooka’, because it really is a last ditch attempt to boost the value of the eurozone economy.
For it to work, it needs to stave off deflation, which would be disastrous for the eurozone economy as it was in Japan.
When prices are falling because of deflation, consumers and businesses tend to put off their buying decisions, and the economy shrinks even faster.
The ECB wants to get price inflation across the eurozone back to 2%, from where it is currently at close to 0%, so this big bazooka of QE should help.
But this particular programme of QE is like nothing we have seen before in the UK, US or Japan.
It is incredibly complex as it has to be applied across the entire euro area. This Sunday there is a general election in Greece which could result in a Greek exit, or Grexit, from the eurozone.
Despite firing this big bazooka, Europe is far from safe.
Here’s what Paras Anand, Head of European Equities at Fidelity Worldwide Investment, had to say yesterday afternoon about the ECB announcement:
“As the details of the ECB’s quantitative easing plan are brought into focus, the debate around the merits of the programme continue in the background. I believe the ECB’s strategy has as many shortcomings as potential benefits and it is hard not to feel a sense of disappointment at today’s announcement.”
Anand goes on to say: “One of the more widely discussed points is the extent to which the ECB, by positioning itself as an ever-present buyer of government debt, eases the pressure on economies that desperately need to enact structural reform to do so. Economies across the region, particularly Italy and France, need to take tough measures today to unlock the longer term potential within their well-educated and skilled labour markets and drive both competitiveness but importantly new business formation. Again, it would seem that quantitative easing in and of itself can help little in this regard.”
He concludes by saying: “I fear that the current programme with its focus on ultimate recourse and legal obligations under various negative scenarios is pulling us in the opposite direction.” That is, the opposite direction to greater collaboration between governments across the region.
Time will tell whether firing this big bazooka was enough to save the eurozone economy.
Investment markets have reacted positively, with the FTSE 100 index of leading UK company shares at 6,810 as I write this at midday on Friday.
