Draghi's dilemma : To QE or not to QE?

It seems as though the European Central Bank (ECB) has been debating whether to head down the quantitative easing (QE) path forever. ECB-watchers have been reduced to pondering what Mario Draghi's (usually) various shades of blue ties might mean for future asset purchases.

This week, the bank is expected to announce the details of its first round of what is being called by many private-sector QE, no matter how reluctant Draghi may be to label it as such.

Martin Leissl | Bloomberg | Getty Images

When first announced, the mass buying of private-sector assets seemed to be the fillip markets have been hoping for – especially as, if it follows the pattern established by the U.S. Federal Reserve, there may be public-sector asset purchases soon (within six months, according to Mark Wall, chief economist at Deutsche Bank).

Yet is this really the best thing for the increasingly stagnant economies of the euro zone?

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The widening of euro zone government bond spreads last week, following yet more weak economic data for the single currency region, suggests both markedly less confidence in the region's weaker economies and a reduction in expectations of a QE bazooka.

The example of Japan, which had its worst economic quarter since the 2011 earthquake in April-June, is rapidly becoming less encouraging.

If there was huge confidence in the ECB's ability to deliver the right kind of economic stimulus, why would slightly weaker data deliver this reaction in the bond markets?

Of course, the ECB cannot do everything, and the market reaction is partly because of increasing lack of confidence in politicians' ability to deliver the fiscal and structural policies which would reduce the need for asset purchases.

Yet there are also valid concerns about the disconnect between the amount of cheap money pumped into the European banking system, and the take-up by the real economy. Loans to non-financial borrowers are still slowly reducing, as deposits rise, and this appears increasingly to be down to lack of demand. If businesses are feeling confident, why are they not borrowing to fund their future expansion?

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And if the ECB, as expected, plans to buy top-quality asset-backed securities and covered bonds, this may reduce the amount of the best-quality assets held by banks, just as the crucial asset-quality review focuses attention on who is holding the least-secure assets.

There is also the question of whether the ECB will find enough assets in this round to meet the targeted 1-trillion-euro ($1.3 trillion) growth of its balance sheet. With a worse-than-expected take-up of its latest cheap loan program, dubbed TLTRO, it may be forced to expand beyond the private-sector remit faster than planned.

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