The Americans are doing it. The Canadians are doing it. Why not the Europeans?
The United States and Canada are raising interest rates – the Bank of Canada did so again on Wednesday, fully reversing the cuts of 2015. At the same time, the U.S. Federal Reserve is now examining ways of selling the massive amounts of bonds it acquired under the quantitative easing (QE) program.
In other words, "policy normalization" is under way in the United States and in Canada. Not in Europe. On Thursday, the European Central Bank left interest rates unchanged and is sticking to the script on QE. The ECB will continue buying €60-billion a month of bonds at least through December – "or beyond if necessary" – as long as inflation remains a fair amount below its target of close to 2 per cent.
It gave no details on how it expects to end the €2-trillion QE program, even though the great unwinding should happen fairly soon. At a press conference in Frankfurt, ECB president Mario Draghi said the ECB's governing council on Thursday held "very, very preliminary discussions" on how to wean the markets and the economy off QE. The "bulk of these decisions" on QE tapering will be made in October, he added.
Analysts and economists expect the ECB to ease its foot off the QE gas in early 2018, perhaps by reducing the monthly bond purchases by €20-billion or so. Whatever happens, the process is expected to be fairly slow, for fear that axing QE overnight would drive up bond yields in a hurry, lifting the debt financing costs of struggling countries like Italy and sending the euro on a tear. A strong euro is bad news for exporters and has a dampening effect on inflation.
Euro-zone growth is strong – the region's gross domestic product is expected to rise 2.2 per cent this year, according to the ECB's newest forecast. Unemployment is sinking and six million jobs have been created since 2013. Inflation, while still below the target level, is in place; the threat of deflation – falling prices – is long gone. The Germans, never fans of the QE money-printing juggernaut, are calling for its demise. So are bankers. On Wednesday, Deutsche Bank boss John Cryan said the era of QE and ultra-cheap money has to end because they are warping asset values. "We are now seeing signs of bubbles in more and more parts of the capital market," he said at a conference in Frankfurt.
So why has Mr. Draghi been so slow, perhaps afraid, to kill off QE? In good part, blame the soaring euro. It hit $1.20 (U.S.) after Mr. Draghi's press conference. That's up 14 per cent against the dollar this year and 6 per cent on a trade-weighted basis. While the exchange rate is officially not an ECB policy concern, there is no doubt it's weighing heavily on Mr. Draghi's mind. "The recent volatility in the exchange rate represents a source of uncertainty which requires monitoring," he told the media.
Mr. Draghi would not want a much stronger euro – the current level is strong enough, perhaps too strong. He would not want a much weaker euro, and he surely doesn't want a highly volatile euro, which drives corporate treasurers and finance directors crazy.
There is a good chance the euro could go on a roller-coaster ride in the next few months and here's why: Donald Trump.
The U.S. President wants to overhaul the tax code. This week, he promised "major, major tax cuts [for individuals], the biggest since Ronald Reagan," and an effort to "cut the business tax rate as much as possible, ideally [to] around 15 per cent." The top tax rate for corporations is now 35 per cent.
If Mr. Trump's tax gamble pays off, the U.S. dollar would probably soar, all the more so if it motivates big American companies, like Apple, to repatriate the trillions of dollars they have stashed overseas in tax havens. If the gamble fails – and it could given Mr. Trump's miserable attempts at pushing through legislation – the dollar would probably sink.
A soaring or sinking greenback could have a drastic effect on the euro. If the euro sinks a lot because of a suddenly higher dollar, the ECB would have the cover to ditch QE fairly quickly. If the euro soars against a suddenly weaker dollar, the ECB might want to keep QE in place somewhat longer.
Mr. Draghi did not mention Donald Trump or his tax plans at the press conference. Why would he? But he did mention exchange-rate volatility. If anyone can ensure exchange-rate volatility, it's Mr. Trump, and that might be why the ECB is loath to make key decisions today as to when and how QE will drop away.