James Bevan: The ECB’s next choice for QE and rates
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James Bevan
Back in 2014, it was widely expected that any form of government bond purchases (and therefore overt quantitative easing – QE) by the European Central Bank (ECB) would ultimately be judged unconstitutional by the European Constitutional Court.
This turned out not to be the case, but Mr Draghi and the ECB did spend the latter part of 2014 talking bond yields down via a series of vague promises and official rate cuts, with the result that by the end of December German 10 year bond yields had fallen to around 50 basis points, and we can suspect that that was where the ECB wanted then to be at that time.
At this level, yields were low enough for both private and public sector borrowers, but they were not catastrophically low from the point of view of savers and investors.
However, in January 2015, the European Courts unexpectedly decided that a QE was constitutional and within days of this announcement the ECB had been pledged, not by its governing council but by its political masters, into enacting a form of QE.
The result was a further decline in bond yields to levels which the ECB staffers apparently regarded as being “too low”.
Certainly, there are clear signs that the ultra- low yields have done more harm than 
good to the real economies, most notably by encouraging the savings rates in a number of countries to begin rising.
Then, as a consequence of this development, the ECB took the perhaps unprecedented step of trying to talk bond yields up in early May 2015, and the result was the Bund “flash crash” that revealed just how fragile and illiquid Europe’s debt markets had become.
Thereafter, a somewhat chastened ECB retired from making many more comments and went back to hoping that low oil prices, the low Euro and even its QE might generate recovery.
However, with no real recovery yet visible, and with Emerging Markets teetering on the age of crisis, the ECB has been called upon to do more, and it has indeed pledged to do something.
The question of what to do is now quite pressing: more QE and yields that are even further away from where the ECB thinks/thought they should be looks irrational.
They do have an alternative way forward – they could pare back government bond purchases but extend aggregate QE by purchasing a huge amount of European Investment Bank debt.
The EIB could then spend this money on a direct boost to the European economies via infrastructure expenditure.
This monetized public sector investment could provide both a short term lift to European GDP growth and longer term benefits to the European economy.
But this sort of policy initiative would require concerted effort by politicians which may not be forthcoming. That said this difficulty is not a good reason for the ECB to do something irrational instead, such as more of its already unwanted QE.
The problem is not just missed opportunity – an ECB policy decision to cuts rates, taking them into more negative territory, and to undertake more of the same QE would risk a significant adverse market reaction.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
*CCLA is a supporter of Room151
