Reguly: The EU’s debt-crisis saviour could be its undoing

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In his five years as President of the European Central Bank, Mario Draghi has been Capitano Europe, battling on every front to keep the euro zone intact and inflation alive. Bloodied and exhausted, he can declare a victory, of sorts. No country has left the euro zone, although Greece threatens to do so with tedious regularity, and the deflation threat seems to have vanished.

But since no good deed goes unpunished, Mr. Draghi will soon be thrust into battle again. His opponent this time? Germany.

Germans loathe inflation, and inflation, thanks to Mr. Draghi's stimulus program, quantitative easing (QE), has come back. Fresh data this week revealed that euro zone inflation reached an annual rate of 2 per cent in February, the highest in four years. The ECB's mandate is to keep inflation close to, but under, that level.

German inflation was even higher, at 2.2 per cent, making Germans twitchy. "It's high time for the ECB to move away from its ultra-loose monetary policy," Bavarian Finance Minister Markus Soeder told the Frankfurter Allgemeine Zeitung newspaper.

He was referring to the ECB's zero interest rate policy and QE, which has been buying bonds at the rate of €80-billion ($113.4-billion) a month. By February, the QE tally had reached more than €1.5-trillion. If Germany had its way, interest rates would go up and QE would go down, way down, perhaps to zero. Germany always considered the 2-per-cent inflation target arbitrary . Their central bankers would argue: Why not 1.5 per cent or 1 per cent?

But here's the problem, and it's a biggie. QE was never just about driving down bond yields and pumping stimulus into the economy. It was also a soft bailout of the Mediterranean countries, notably Italy and Portugal, although that was never stated (Greek bonds are not eligible for purchase by the ECB because Greece is under bailout review).

The QE security blanket is still in place, but it could be removed now that inflation has returned. The ECB's asset purchases are to drop to €60-billion a month starting in April. If core inflation picks up momentum – it's running at about half of the headline inflation rate – QE could be wound down fairly quickly. That would please Germany no end.

Once the QE security blanket is gone, all sorts of nasty things could happen to the weakest euro zone countries. Their sovereign bond yields could rise – indeed, they are already – boosting sovereign risk. QE had minimized that risk, knocking down yields across the euro zone and greatly reducing their "spread" over benchmark German bonds, which are the region's safest debt.

Italy would be especially vulnerable because its economic overhaul since the debt crisis has gone pretty much nowhere. Italy has been protected by Mr. Draghi's QE program. Once QE is gone, with nothing soothing to replace it, investors could flee.

The European Union and the euro zone don't need more problems as Britain pulls out of the EU and Euroskeptic populist movements in France, the Netherlands and Italy put the squeeze on the centrist parties.

With inflation beyond the target level, Mr. Draghi will face enormous pressure from Germany to clip QE's wings. At the moment, he can use the relatively low core inflation number to buy QE some time. But he must know that QE's roll-back and eventual end could inflict enormous damage on the countries that can afford it least. The EU and the euro zone are in danger of disintegrating. The end of QE could accelerate that , and wouldn't that be ironic.

Poor Mr. Draghi – QE was supposed to be the euro zone's saviour.