ECB Collateral Damage

In a blog published the day before the ECB announced its asset purchase programme, rather than speculating on how much firepower the ECB was going to deploy or on how effective such a programme would be, I expressed my concerns about the potential side-effects. Unlike Bradley Cooper’s highly precise rifle, which is able to pick off an enemy from miles away, Mario Draghi’s bazooka is a weapon of mass destruction which “imparts strong side effects on neighbouring countries because it leads to massive capital outflows”.

At the time of writing that blog, the casualties were already evident even before the announcement of any potential QE. The Swiss had just given up on their peg to the euro at 1.20, and Alpari UK and FXCM, just to name a few, were caught off guard and hit by the massive leverage provided to their clients, who thought they could trust the Swiss forever. The Nationalbanken in Denmark was another casualty as it had to cut its deposit rate twice, first to -0.05% and then to -0.20%, in order to keep its tight peg of the krone to the euro at the rate of 7.46 +/- 2.25%. Central banks around the world, and in particular those of countries with closer ties with the Eurozone, were preparing for the collateral damage induced by a large-scale asset purchase programme and trying to insulate their economies from a massive inflow of money desperately seeking higher yields. Such inflows lead to upside pressure on the exchange rate and can result in a quick deterioration of a country’s external trade position. At the same time, lower import prices can lead to deflation.

Now that the ECB has confirmed it is going to spend 60 billion euros per month on asset purchases between March 2015 and September 2016, those central banks which preferred to wait and see have now moved or are just about to move into what will be the largest ever global easing we have on record. During the month of January alone, 14 central banks surprised the market with unexpected interest rate cuts and/or unconventional easing measures. In addition to the Eurozone, Singapore, Switzerland, Denmark, Canada, India, Turkey, Egypt, Romania, Peru, Albania, Uzbekistan, Pakistan and Russia have all eased their monetary stance since January.

Just after the ECB announcement, Denmark had to cut its deposit rate for the third time in less than one month, to -0.50%. Whether the tight peg of the Danish krone to the euro is going to be broken and hit FXCM for a second time in the same year remains to be seen. Economists unanimously agree that the Danish case is not similar to the Swiss and that the peg is very strong and unshakeable. But I also remember the comments two months ago stating that oil would never hit $50, so…

Speaking of casualties, February brings another country to the easing queue. Yesterday the Reserve Bank of Australia decided to cut its benchmark rate from 2.50% to 2.25%, and many expect the bank to cut its main rate even further in its next meeting. The Australian base rate is already at a record low, and yesterday’s cut represents a relapse in the bank’s policy, as it had stopped easing in August 2013. Even though, at first glance, the ECB may not be deemed responsible for the RBA, in a world where capital moves freely and money flows from one country to another in just a matter of seconds, no central bank is able to completely detach from the policy decisions of its peers.

After global central banks adopted the easing standard in 2007-2008, they could never get rid of it. We’re entering a new era for economic policy, one that is dominated by highly indebted countries, which don’t have any budget margin to deal with recessions and thus rely too much on monetary policy as an adjustment tool. But, while academics disagree on many things, they at least agree on one major issue: monetary policy isn’t able to drive growth in the long run. After years of monetary easing, it should by now be time to reverse policy and rely on other tools to re-launch growth. But rather than doing so central bankers are willing to go even deeper and are testing another tool: negative interest rates. How far are they willing to go? How negative can an interest rate be set before people start hoarding cash? That is the next level for monetary policy… one that can very well end with the suggestion of a complete cash ban.