Markets threw a tantrum because they did not get instant gratification, but the ECB’s radical stimulus is unprecedented.
The European Central Bank has cut the deposit rate to a record low of -0.3pc and vowed to print money for as long as it takes to defeat deflation, pushing its radical stimulus measures to extremes never seen before in any major region in modern history.
The far-reaching moves come despite signs that economic growth in the eurozone is picking up, and ignores vehement protests from German-led hawks that quantitative easing at this late stage is doing more harm than good.
Mario Draghi, the ECB’s president, said the bank will keep buying €60bn of bonds each month as far out as March 2017 or “beyond if necessary”. It is effectively an open-ended pledge. “Abundant liquidity will continue for a long, long time,” he said.
Markets were betting on even more largesse, and reacted badly to the package of measures.
Many funds had expected an increase in the volume of QE purchases to nearer $80bn and an even deeper cut in the deposit rate, beguiled by the ultra-dovish rhetoric of top ECB officials over recent days.
The euro soared by almost 4pc to $1.0933 against the dollar, smashing through technical stops in a bloodbath on the exchange markets.
“It was the biggest one-day rise in the euro since 2009,” said Ian Stannard, from Morgan Stanley.
Germany’s DAX index of equities and France’s CAC 40 both fell 3.6pc, the worst drop since August. The FTSE 100 dropped 2.3pc to 6,275.
Yields on 10-year German Bunds spiked violently by 19 basis points to 0.66pc, with even more drastic reversals in Italy and Spain.
An estimated €300bn of eurozone debt trading at negative rates has turned positive again within a single trading day, reducing the total to €2.2 trillion.
“Markets want immediate gratification. A lot of traders had large positions and they got caught out,” said David Owen, at Jefferies.
“But when things settle down in a couple of weeks, people will realize that what happened today is highly significant. The ECB is adding another $360bn to its balance sheet and is now reinvesting its portfolio, like the Bank of England. This is a big deal,” he said.
The ruckus on trading floors had echoes of August 2012, when Mr Draghi launched his back-stop plan for Italian and Spanish bonds (OMT), ending the eurozone debt crisis at a stroke.
Markets sold off in a knee-jerk fashion at first but soon changed their mind as the significance sunk in.
Mr Draghi said QE has been an unqualified success but the summer storm in emerging markets and China diluted the effects, while the commodity crash has made it even harder to fight deflation. Inflation is still stuck at 0.1pc, leaving little safety margin against an external shock.
“We are doing more because it works, not because it fails,” said Mr Draghi, insisting that the eurozone would have been in outright deflation this year without QE.
Yet it is far from clear whether the region needs radical stimulus as far ahead as 2017, given that the ECB itself is predicting above trend growth of 1.7pc next year. Euroland is already benefitting from a near perfect storm of positive shocks.
Fiscal austerity is finally over. The euro has fallen 13pc in trade-weighted terms since April 2014. Oil prices have plummeted from $114 a barrel to $43 in 18 months, giving consumers a shot in the arm.
Euro trade-weighted exchange rate
“It’s going to be harder and harder for them to follow through on QE,” said Simon Smiles, from UBS.
He said business sentiment in the eurozone is rising briskly and Spain is beginning to display pre-Lehman forms of overheating. The eurozone’s PMI services index rose to a 54-month high in November.
“This is hardly an environment for further exceptional accommodation. We think the talk in the markets is going to switch to when the ECB turns, perhaps by the end of the first quarter,” Mr Smiles said. UBS said the euro is seriously under-priced, with fair value near €1.25.
The money supply is catching fire. Narrow M1 – cash and checking accounts – is rising at a blistering pace of 11.8pc.
The transmission mechanism is damaged and the lag times are unpredictable, but this could set off a sharp pick-up in economic growth next year.
The broader M3 measure is rising at 5.3pc. In Germany it has reached 8.5pc and may soon hit double-digits, a threshold likely to set off alarm bells in Frankfurt.
Jens Weidmann, the head of the Bundesbank, has warned repeatedly over recent days that there is no justification for further stimulus.
“The longer that extreme monetary policy continues, the less it works and the greater the risks and spillover effects that come into play. We shouldn’t forget that the measures already taken require time to work their full effects,” he said.
The Bundesbank warns that negative rates are causing serious problems for savings banks and smaller lenders, and make it much harder for insurance companies to match their maturities.
Hans Werner Sinn, from the Germany’s IFO Institute, said Mr Draghi has given up trying to conduct a responsible monetary policy and is engaged in a covert rescue of ailing banks and governments. “The ECB has turned into a bail-out machine,” he said.
Both German members of the ECB opposed the new measures, and were almost certainly joined by hawkish governors from the Netherlands and the Baltics.
They may have stopped Mr Draghi going even further. “The ultra doves lost the argument,” said Frederik Ducrozet, from Pictet.
Gabriel Stein, from Oxford Economics, said the ECB is right to ice the cake until recovery is entrenched, even if only as an insurance policy. “This was definitely warranted. There have been too many false dawns,” he said.
“The great recession took a huge bite out of the eurozone economy, and there is still a lot of slack.”
Tim Congdon, from International Monetary Research, said the region will languish in semi-slump whatever the ECB does as long as banks are being forced to their beef up their capital buffers and restrict credit.
Lenders must raise the ratio of “loss-absorbing capacity” to 16pc of risk assets by the end of the decade under new global rules. “This condemns Europe to a further five-year sentence of low growth,” he said.
For Mr Draghi, it is a day he would probably rather forget. He delivered exactly what he promised yet for mysterious reasons the markets concluded otherwise. Sometimes you just can’t please them.