TalkingEconomics: As ECB begins QE, Greece votes for austerity to end
In Europe, neither quantitative easing (QE) nor softer loan conditions for Greece (if the newly elected far-left Syriza are successful in fulfilling their promise to end austerity and ease bailout conditions) will fix the underlying problems both face. Greece and the eurozone need structural reforms, otherwise, they risk taking the same path as Japan.
ECB takes leap of faith
The European Central Bank’s (ECB) QE programme that was announced in January will benefit the eurozone economy by reducing the risk of deflation. However, the purchase quotas may be difficult to fill given two important factors: the ECB can only buy 25% of any individual bond issue and can only make purchases in proportion to the individual country’s subscription to the ECB’s capital base. These factors will limit the number of bonds available to the ECB and if the ECB were to deem the scale of purchases to be insufficient to boost growth, it would seriously struggle to expand its programme any further. Furthermore, the ECB will potentially be buying more than three times the issuance of new government bonds between March 2015 and September 2016. This can certainly push bond yields in Europe to fall further, which in turn lowers interest rates offered by banks to the real economy. This is useful but we feel that the main impact will come through from the weaker euro, which will make European exporters more competitive internationally.
The results of Greece’s elections are a setback but not necessarily a disaster.
It is important to note that QE is not a panacea for the monetary union’s ills; for this, deep structural reforms are required. Ironically, QE will reduce the incentive for governments to implement these as it introduces a distortion to bond markets and removes the discipline that comes from market pricing based on fundamentals. Without reforms, the ECB may be forced to add additional stimulus as growth falters again, which in turn reduces incentives further. Could this be the downward spiral that leads Europe down Japan’s path?
Greek backlash against austerity
In our view, the results of Greece’s elections, which saw the far-left Syriza party win the most votes and parliamentary seats, are a setback but not necessarily a disaster. Yet another leader promising hope and a rollback of austerity has been elected, but he will probably fail. President Hollande in France is just one example of such false hope.
Where now for Greece?
As we see it, the situation in Greece can play out in one of a few scenarios:
- Benign outcome. Syriza wins some concessions from the Troika in exchange for continuing with reforms. The economy slows but avoids a recession and the impact on wider Europe is insignificant.
- Syriza fails. Syriza fails in its Troika negotiations and is unable to deliver its promised fiscal changes. The coalition breaks down and the economy slows but the wider implications are insignificant.
- Grexit. Syriza fails to reach a compromise with the Toika and refuses to pay interest on Troika debt. Europe halts ECB liquidity funding to Greek banks, leading to bank runs. Eventually, Greece is forced to leave the currency union. The Greek economy suffers a deep and prolonged recession, with negative spillovers in Europe.
- Troika out, but no Grexit. Troika negotiations end in stalemate with no further credit provision. Greece continues to service its loans, but has to run a larger surplus. Greek banks remain supported by the ECB so Greece stays in the eurozone. The added austerity causes a recession but spillover effects are temporary and small.
Greece’s future now depends on whether Syriza can govern in a responsible way, and recognise that major structural reforms are still needed. Unfortunately, it is hard to find optimism on this front given Syriza rhetoric. Meanwhile, Greece’s membership of the EU depends not only on structural reforms, but also on Alexis Tsipras’s ability to reach an acceptable compromise with the Troika. We are almost certainly going to see a standoff in negotiations in the near-term. The risk of ‘Grexit’ is once again elevated and investors should think very carefully before investing in Greece.