World Economic Forum: All Eyes on European Central Bank

Davos – Clearly enjoying her role as the real moneybags of the World Economic Forum (WEF), German Chancellor Angela Merkel – small in stature but as ever a commanding presence – lashed out at Russia yesterday for its “flagrant violation” of the territorial integrity of Ukraine. While willing to accommodate “Russian sensitivities,” Mrs Merkel only suggested a slightly slower pace for Ukraine to draw closer to NATO. She also reminded Russian President Vladimir Putin that the ultimate goal should be his own plan to extend economic cooperation from Vladivostok to Lisbon.

Asked by Prof Klaus Schwab, WEF founder and chairman, for her take on Sunday’s elections in Greece and the possibility of a “Grexit,” Chancellor Merkel dismissed the country’s withdrawal from the Eurozone as an “immediate possibility” and said she understands that a clear majority of Greek voters wish to keep the euro. Mrs Merkel called on Greece to shoulder its own responsibilities and praised the Athens government for the painful reforms already carried out. Chancellor Merkel also assured the Greeks that they may continue to count on the “solidarity” of other Eurozone member states.

The second day of the Davos meet saw participants scrambling to interpret the historic, though belated, move by the European Central Bank (ECB) to kick-start the Eurozone’s stalled economies via quantitative easing (QE) – a stratagem employed earlier, with mixed results, by the US Federal Reserve, the Bank of England, and the Bank of Japan.

“Chancellor Merkel also assured the Greeks that they may continue to count on the “solidarity” of other Eurozone member states.”

ECB President Mario Draghi unveiled a larger-than-expected intervention, promising to buy up government and corporate debt at a monthly rate of €60bn, starting next March. The ECB will keep buying bonds until September 2016, or beyond should inflation remain below the bank’s stated target of 2%.

The euro took a predictable nosedive to close at $1.13 – nearing an 11-year low and down almost 2% for the week. However, stock markets around the world sprang to life on the news from Frankfurt with the S&P500 and the Dow gaining as much as 1.5% overnight. In Japan, the Nikkei gained 1% while by the end of yesterday’s trading the German DAX benchmark index had jumped 1.32% to close at an all-time high. The midcap MDAX added 1.52%. Stocks in neighbouring Switzerland fared less well with the Zürich market failing to join the global rally, ending down 0.11% in a day of volatile trading.

In Davos, the assembled pundits were duly impressed by the scale of the ECB’s QE programme, though concerns remain about the new risk-sharing scheme adopted at the behest of the Germans. Each of the 19 national central banks that together with the ECB form the Eurosystem will be solely responsible for any losses incurred on the (sovereign) bonds it buys. The ECB’s exposure remains limited to 8% on government-issued bonds and 12% on bonds issued by European institutions. There is to be no pooling of risk – as was the norm until now – which could signal the start of Eurozone fragmentation.

It is as of yet not clear if Greece will receive its share of the QE billions. The ECB has set a number of minimum standards for bonds to be eligible for purchase. These are sufficiently ambiguous that Greece could be left out in case the country’s new government decides to review its commitments under the earlier bailout agreement.

Managing Director Christine Lagarde of the International Monetary Fund (IMF) commented that the ECB’s QE drive already seems to be working: “If there is some re-anchoring of inflation in the euro area, those emerging European markets, which are pegged to the euro, will have the benefit of that.” US Secretary of the Treasury Larry Summers, also in Davos, exclaimed: “I am all for European QE!”

Others were slightly less excited. Citigroup’s Chief Economist Willem Buiter called the move by the ECB a “poor man’s monetary policy” and added that it will fail to encourage robust economic growth. “The policy is designed to not to disappoint financial markets, but only just, and will probably fail to get Europe’s economy out of its rut,” concluded Mr Buiter.