Observations on the Greek Election and the European Central Bank – Part One

Since January 22, 2015 when Mario Draghi, President of the European Central Bank (ECB), announced an expanded asset purchase program, there has been growing sentiment (as cited by the Wall Street Journal and other commentators) that it is more certain the U.S. Federal Reserve will move to increase interest rates late in the 2015 second quarter, or third quarter. To be considered then by U.S. investors and businesses, the rational for an increase in interest rates by the Federal Reserve could be inferred as undertaken as a mechanism in support of restoring EU (and global) growth. 

However also to be considered, is that if the dollar continues to surge in light of the ECB action the Federal Reserve may delay a rate increase, also in support of the EU (and global) economy. Many commentators are also of the view that when considering interest rate increases the Federal Reserve will also review U.S. inflation and equity markets performance, and the movement of foreign currencies; these factors as well should be observed by U.S. investors and businesses.  

What was driving the ECB’s January 22 announcement?

 First the ECB has decided to launch an expanded asset purchase program for asset-backed securities and covered bonds. Under this expanded program the combined monthly purchases of public and private sector securities will amount to 60 billion euros. To attain this objective, the program is intended to be carried out until end-September 2016 and will be conducted until the ECB sees a sustained adjustment in the path of inflation which is consistent with the ECB’s aim of achieving inflation rates below, but close to, 2% over the medium term.

In March 2015 the Eurosystem will start to purchase euro-denominated investment-grade securities issued by euro area governments, agencies and European institutions in the secondary market. Second, the ECB Governing Council decided to change the pricing of the remaining targeted longer-term refinancing operations.

Regarding additional asset purchases, the Governing Council will retain control over all the design features of the program and the ECB will coordinate the purchases, thereby safeguarding the singleness of the Eurosystem’s monetary policy. With regard to the sharing of hypothetical losses, the Governing Council decided that purchases of securities of European institutions (about 12% of the additional purchases) will be subject to loss sharing. The rest of the NCBs’ additional asset purchases will not be subject to loss sharing. The ECB will hold 8% of the additional asset purchases; this implies that 20% of the additional asset purchases will be subject to a regime of risk sharing.

The ECB monetary policy decision on additional asset purchases was taken to counter two unfavorable developments.

 First, inflation dynamics have continued to be weaker than expected. Second, while ECB monetary policy measures adopted in 2014 resulted in a material improvement in terms of financial market prices, it was insufficient to adequately address heightened risks of a too-prolonged period of low inflation. Thus, the additional measures now adopted are necessary to achieve the ECB’s price stability objective, as interest rates have reached undesirable levels, and help inflation levels to grow to a 2% target rate.

Additional detailed information on the expanded ECB asset purchase program is forthcoming (Part 2, Part 3), as well as observations and considerations as a result of the Greece elections on January 25, 2015.