Dragons take time on the Qe because of the strong euro

Mario Draghi Takes Time on Qe Quantitative Easing: The decision about the next downsizing of the Slip Brokerage Program in October. And it does so by pushing itself to the maximum limit in exchange rates: it describes the strong euro as a “source of uncertainty” that is beginning to worry. But the euro, instead of depreciating as one would have expected, driven by strong European growth, flies above 1,20 dollars, the guard threshold already reached last week. That Draghi's press conference would have been geared towards a defense against the pressure of the 'hawks', it was clear ever since the ECB announced, together with the rates left unchanged, that quantitative easing can still increase if the economic situation worsens : a cheasing bias that some expected to be removed, as a sign of an upcoming downsizing of Qe. Draghi instead sent a strong message of caution on the farewell to Qe in the course of 2018. The strong euro - based on a mid-August estimate at 1,18 which is now even outdated - "represents a source of uncertainty that needs to be monitored" so much so that "fears" among several governors in Frankfurt are increasing. For the depressive effect on exports and growth. But also for the impact on inflation (a strong exchange rate decreases the imported one), the second pivot of Draghi's speech, where the ECB made a significant downward revision of its forecasts (it remains at 1,5% this year, but drops to 1,2% next from 1,3% estimated in June, and 1,5% in 2019 from 1,6%). All this in spite of a galloping Eurozone growth, with the ECB's estimate for this year raised to 2,2%. With the Federal Reserve's moves becoming less predictable (Stanley Fischer's farewell increases Donald Trump's influence), the yardstick by which to measure for upcoming QE moves is the euro-dollar exchange rate. "It is very important," says Draghi after having premised the customary phrase according to which the exchange rate is not an objective of the central bank, and the ECB "will have to take it into account". The president of the ECB manages not to disclose its own cards, unless it explains that the board of directors has received various scenarios from the internal committees, which is evaluating, in particular, on changes in the length of the purchased securities and the monthly amounts. "Probably, barring risks that we do not see today, the majority of the decisions on quantitative easing will be taken in October", is the maximum commitment that the press managed to wrest from Draghi. But without tying your hands too much: the ECB "is reluctant to commit to a certain date". And it is clear that a tear in the euro at too high levels - closely linked to the decisions of the Fed which meets at the end of September - could represent a risk factor. Not only that: net of the pressure of the Bundesbank, and of the German vote of 24 September which will precede the ECB council of 26 October by one month, Draghi is weaving a canvas to soften as much as possible the 'tapering', the progressive exit from the Qe . His words on size and duration suggest a strategy to avoid any shortcomings in bond markets to be purchased during the 2018 and perhaps lead to changes in the maximum amount that would make it possible to extend debt purchases. Once again, the Italian central banker found the square in the BCE board. But the markets know that tapering is a matter of time.

What is Quantitative Easing (QE)

To have money to support their economy, their services and their activities, states issue securities that can be purchased by citizens and businesses, including banks. Simplifying: Periodically, a state offers securities that cost X with a maturity, and commits itself to returning the money to those who bought those securities by adding a percentage of interest when these have expired. Those who buy securities can not get the money they invested more interest until they expire, but if they want to sell them on the market or to find something or not to lose too much, in case there are real risks that securities can not be repaid to their securities expiration from who issued them.

The main buyers of these securities are the banks, which therefore have large amounts of immobilized money because they invest in securities (not just state). To create coins, ie to make more money available to get loans from banks and to make investments more easily, a central bank may decide to resort to the QE. In practice, it proposes banks to repurchase securities, usually on favorable terms, hoping that with the money obtained from the sale, individual banks will make it easier for them to access credit, ie the possibility for their customers - citizens and businesses borrow money more easily and lower interest rates.

Quantitative Easing has several consequences, usually related to the economic context in which it is realized. Among the most common is the impact on the cost of living and the power to buy the coin. In short: putting more money into circulation with operations such as QE reduces the value of currency (it is devalued: there is more and this affects demand) and as a result prices increase because the money they make purchases is worth less. This is why inflation is rising - something generally perceived as a negative one because it raises prices, but central banks know well that a minimum of inflation is positive in order to avoid deflation, that is to a progressive decline in prices. Today, for the EU and the eurozone, the nearer and more dangerous scenario is definitely deflation rather than inflation.

Deflation is very risky because it triggers a vicious circle that is damaging to the economy: consumers and companies postpone their unnecessary purchases because they see prices falling further and therefore expect further drops, as a result demand remains weak and producers of goods and services further reduce prices, hoping someone buys. Companies consequently record less revenue, start cuts, and try to reduce costs from those that most affect their budgets, which are usually employees. They also stop lending to banks because they do not want to make other investments, and with less revenue they would not know how to pay for their interests.

According to several economists, one of the most effective solutions to get out of deflation is precisely the use of quantitative easing. The system allows, at least theoretically, to have a rapid impact on the trend of inflation, making sure that it rises again by restarting the economic mechanisms. The path of QE has been followed for some time by the Bank of Japan, which already in the late XNUMXs started a campaign to purchase securities from banks to counter deflation. A couple of years ago the QE policy was strengthened with a very ambitious, and costly plan to increase inflation in Japan: it is the so-called “Abenomics”, the economic policy followed by Japanese Prime Minister Shinzō Abe. The Federal Reserve, that is the central bank of the United States, has implemented QE policies that according to various observers have contributed to the recovery of the US economy recorded in recent months.

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Dragons take time on the Qe because of the strong euro