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Call for QE to Stave Off Euro Deflation

A top European Central Bank policymaker has called for “quantitative easing” to be used to boost the euro zone economy if deflation risks emerge across the 17-country region.

European Central Bank
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European Central Bank

The comments by Lorenzo Bini Smaghi, ECB executive board member, are the strongest indication yet that the central bank would expand its policy tools to prevent a possible disastrous economic slump in continental Europe.

In an interview with the Financial Times, Mr Bini Smaghi also hinted at frustration over the UK’s reluctance to join efforts to strengthen the euro zone. The euro’s success was in the City of London’s interest, he said. “The European Union, and ECB, would certainly contribute to help Britain if London was in difficulty. I would thus expect a reciprocal attitude.”

Speaking in Frankfurt on Thursday, Sir Mervyn King, governor of the Bank of England, said swift implementation of measures to shore-up the euro zone was of “utmost importance”, warning that “stressed financial conditions are passing through to the real economy”.

The Italian Mr Bini Smaghi steps down at the end of the year to make way for a Frenchman on the ECB board. So far, ECB policymakers have been wary about commenting on using “quantitative easing” – creating money and buying assets – if necessary to boost growth prospects. But his comments indicated its possible use had been debated within the central bank.

Mario Draghi, ECB president, sidestepped a question on quantitative easing in an interview with the FT published earlier this week, saying his priority was to restore trust in Europe. “We won’t achieve that by destroying the credibility of the ECB,” Mr Draghi said.

Mr Bini Smaghi said: “I do not understand the quasi-religious discussions about quantitative easing.” Such steps had been taken in the US and UK, where the central bank had seen deflation risks. Currently, the ECB did not see deflation risks for the euro zone. “But if conditions changed … I would see no reason why such an instrument, tailor-made for the specific characteristics of the euro area, should not be used.”

Mr Bini Smaghi stressed the importance of central bankers acting decisively. He did not rule out the ECB stepping up its intervention in euro zone government bond markets – perhaps by announcing a limit for yields or the spread between the yield on German and other governments’ bonds. Germany’s Bundesbank has opposed such a step, saying it would breach a European Union ban on central banks funding governments. Highlighting the splits at the ECB, Germany’s Jürgen Stark is also leaving the ECB board this month after opposing goverment bond buying.

The ECB had a “duty of action” to ensure financial markets transmitted its interest rate decisions to the real economy, Mr Bini Smaghi argued. In an apparent dig at his German colleagues, he said policymakers should not “hide behind lawyers to avoid taking action.”

On Wednesday, the ECB provided 489 billion euros in three-year loans to more than 500 banks as part of its efforts to relieve tensions in the euro zone financial system. Mr Bini Smaghi said the strong demand for ECB funds “may be a sign of confidence gradually returning”.

Many in the markets think the ECB will have to take further action to bring down yields on euro zone sovereign bonds.

David Owen, chief European financial economist at Jefferies, said: “The European Central Bank has helped settle nerves and boost sentiment with its three-year liquidity tender this week. But I don’t expect the fragile truce in the markets will last long. The ECB will surely have to launch QE at some point. I suspect it might be sooner, rather than later.”

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