What is Quantitative Easing? 5 Questions on QE

The European Central Bank (ECB) is set to bring in its own version of quantitative easing (QE) in March, as announced by the ECB president, Mario Draghi on Thursday 22 January.QE has been used in the United States, the United Kingdom and Japan, as a tool to stave off deflation and boost the economy.It is largely seen as the last big economic tool for the ECB and its success or failure could go a long way to deciding the future of the euro and indeed, the European integration project.The EUR/USD rate has fallen to a level of 1.14, as markets react to the news.The programme will last until at least September 2016, and could have sizeable impacts on the euro and pound sterling, as well as other major currencies. It may also trigger a currency war between the euro, sterling, Swiss franc and others.In this post we explain the fundamentals of QE for the Eurozone.

What is quantitative easing, the programme that the European Central Bank is adopting?

Quantitative easing is the large-scale purchasing of assets by a central bank using money that it has newly created.

What is the European Central Bank’s objective with QE?

The main objective of the European Central Bank’s QE programme is to stave off deflation in the Eurozone and return inflation levels to the ECB target level of “just under 2%”. In December 2014 it came in at an annual -0.2%.

How can this be achieved?

In the case of full-blown QE, the European Central Bank would have to buy securities, most probably government bonds, across all 19 nations that make up the Eurozone. QE aims to raise the price of bonds while simultaneously driving down their yields. This is a method used to push banks to invest in riskier assets and lend more to businesses and individuals.

What effect does QE have on different asset classes?

QE causes depreciation in the currency of the affected economy, in this case, the euro. In expectation of the ECB’s QE programme, the euro has reached its lowest level in 9 years against the US dollar. Bond prices are likely to rise, producing lower yields.Prices of commodities, including precious metals, are likely to rise. Gold rose above $1,300 ahead of the important ECB meeting on Thursday 22 January where QE will be the main focus. European stock markets have climbed to their highest levels in 7 years, in expectation of QE implementation.

What is the expected volume and length of the programme?

The ECB will start purchasing government debt in March of this year until at least September 2016.Purchases of €60 billion will be made on a monthly basis. It is likely to be rolled out month by month for at least a period of two years.If interest rates are not on target, the ECB will likely extend the programme as ECB President Mario Draghi stated that the programme would continue until there is “sustained adjustment in the path of inflations that is consistent with our aim of achieving inflation of close to 2 per cent.”***