While Brexit, the refugee crisis and Greece dominate headlines, the European Central Bank must soon address two more mundane, but no less vital, issues for the eurozone: the future of quantitative easing and banks’ continued addiction to government debt. But this being Europe, all issues are dilemmas, inviting controversy, entrenched views and the risk of impasse.
With QE, the problem is that the asset purchase programme is set to end in March, likely before it will have delivered on its promise to bring inflation back up to the 2 per cent target. Not unreasonably, central bankers have hinted that QE, critical to the resumption of credit and growth, may be extended. Not surprisingly, there is also opposition to doing so.
With banks, the problem is that their balance sheets are stuffed with government paper. At a turn in market sentiment, lower sovereign bond prices can quickly translate into bank distress, and rebound on confidence in the sovereign, which ultimately stands behind banks in times of crisis. The return of this “bank-sovereign death loop” becomes more likely once the price support from QE ends. Regulators are hinting at limiting the exposure of banks to their own sovereign, while countries like Italy oppose the loss of ready financing.