I love movie sequels. In any sequel, by definition, you know what the story is about ahead of time, so the plot itself hardly ever surprises you. Nevertheless, a sequel can be appealing if you’re enamored by the characters, or if there are surprising twists in the plot line.
Alas, the European Central Bank (ECB) sequel—Europe’s second round of quantitative easing (QE2)—was a dud.
The ECB’s Monetary Stimulus Program is Disappointing
ECB President Mario Draghi, in his typical flamboyant way (at least for a central banker), announced in October that the ECB was getting really serious about disinflation in Europe and was going to do whatever it took to get inflation up and up quickly.
Whenever Draghi made such announcements in the past, the ECB typically delivered with full force on its guidance. As a result, the bond and currency markets got themselves all worked up in a lather as to how decisive the ECB’s QE2 was going to be. Anticipated outcomes included a combination of massively negative deposit rates, a larger and broader asset purchase program, and additional latitude for the ECB to purchase assets beyond the initial scope of the QE program.
Unfortunately, the ECB’s QE2 disappointed the markets on all counts relative to expectations. The deposit rate cut was a mere 10 basis points. The mix of assets to be purchased was barely expanded. Also, while the asset purchase program was extended, the amount of the purchases themselves remained the same.
Following Draghi’s announcement this morning about the ECB’s QE2, it appears that, for the first time in a while, Draghi over-promised and under-delivered. I believe that in the short term, this development will prove to be problematic for the markets. After all, the ECB was supposed to be the standard bearer of easy money policies, with the U.S. Federal Reserve poised to tighten policy this month despite a slowing economy. (A recent report by the Institute for Supply Management, or ISM, shows that even the U.S. services sector is slowing.)
Therefore, in my view, challenges for the markets are mounting. My hope is still that the Fed goes out of its way to emphasize its gradual approach to policy tightening. Otherwise, the markets will face an even greater problem.
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