Greek crisis jolts QE juggernaut as ECB ponders deflation

Mario Draghi has more evidence than ever to start quantitative easing as soon as this month — if only he can find a way to deal with Greece.

Two weeks before the first monetary-policy meeting of the year on Jan. 22, governors gathered yesterday and discussed the decision over dinner. Hours earlier, data showed the first annual drop in consumer prices since 2009 and stubbornly high unemployment, handing the European Central Bank president a stronger case for buying government bonds.

Overshadowing their meal was the return of Greek tensions, with the prospect that elections three days after the meeting will bring a party to power that wants to restructure the nation’s debt. That threat adds a new dimension to the argument for Draghi, whose chief challenge in convincing opponents of quantitative easing is to show it won’t turn into a bailout for recalcitrant governments.

“The case for further ECB action is strong and the negative rates of inflation will provide great mood music for Draghi to push QE through the Governing Council,” said Nick Kounis, head of macro research at ABN Amro Bank NV in Amsterdam. “The Greek issue could complicate the announcement and the ECB may well hold off from providing the details until March, giving it a chance to see how the situation turns out.”

Euro-area consumer prices dropped an annual 0.2 percent in December as oil costs plunged, and November unemployment remained near a record at 11.5 percent. Draghi has argued that slumping energy prices may worsen inflation expectations, a development the ECB won’t be able to ignore.

A decision in favor of large-scale government-bond purchases still has hurdles to overcome. Policy makers including Bundesbank President Jens Weidmann have spoken publicly against them, citing legal risks and the likelihood that a program would reduce the incentive for governments to reform their economies.

The treatment of Greek bonds, which are rated junk by the three major credit-rating companies, demands particular attention by officials. The ECB already owns 8 percent of the nation’s debt, and has committed to accept it as collateral in refinancing operations as long as the country stays in a program to ensure its reform efforts stay on track.

Greek opposition party Syriza, which leads in opinion polls, has campaigned on an anti-austerity platform that includes relief on the nation’s debt. That leaves the ECB facing a dilemma over whether to buy the bonds.

Debt relief

Germany is open to discussing debt relief with Greece’s next government, lawmakers in Chancellor Angela Merkel’s coalition said yesterday. While writing off Greek debt isn’t on the table, talks on easing the repayment terms on aid are possible after the Jan. 25 elections, the lawmakers from Germany’s two biggest governing parties said. The condition is that Greece sticks to its austerity commitments, they said.

Before then, on Jan. 14, the European Court of Justice will publish an opinion on a previous ECB plan to buy sovereign debt. That case was referred by Germany’s Constitutional Court, which said last year that the central bank probably overstepped its authority with the so-far-untapped OMT program.

The ECJ opinion, while non-binding, “could have some implications for the way in which a QE program was implemented,” BNP Paribas SA economists including Paul Mortimer-Lee and Kenneth Wattret said in a note. “The probability of the ECB opting to shy away from risk sharing is higher than the market is currently pricing in.”

QE options

ECB staff are working on various forms of QE, and Chief Economist Peter Praet has hinted at two options aimed at mitigating risks. One approach would be to target only the highest-rated assets, while another would be to make each national central bank exclusively liable for the bonds it buys.

While the second option may address a ban on mutualizing debt and make QE more palatable to the broader public, the purchases could still affect the balance sheets of other central banks. As the money feeds through financial markets, it may create liabilities in the region’s Target2 payment system.

“Whether the ECB will announce QE on Jan. 22 is unclear,” said Torsten Windels, chief economist at NordLB in Hanover. “The election in Greece may be an obstacle, but it may also be an incentive to shield Europe to say: Whatever happens in Greece, the ECB will continue to be active. I’d expect the latter.”