ECB fears on asset inflation
The ECB’s €1.1tn quantitative easing (money printing) programme will have a limited impact on the banking system, although it could lead to further economic imbalances through asset price inflation, according to a new report.
Ratings agency, Standard & Poor’s, says that the most positive effect quantitative easing will have on the Eurozone banking system will be over the medium term if it leads to a pick-up in economic activity in the region.
ECB president, Mario Draghi, announced in January from March, the bank would purchase up to €60bn of sovereign and corporate debt every month until September 2016.
The €1.1tn programme is aimed at raising inflation closer to the ECB’s 2% target. The region is in a deflationary environment following the collapse in oil prices.
Despite the huge volume of money that is about to be pumped into the banking sector, S&P believes that it will have a limited impact on profitability.
It will have a much greater impact in countries where funding costs are at elevated levels as it will lead to a lower cost of funding.
It will also have a positive impact on the cost of capital that banks will be required to hold as part of the new Basel 111 regulations.
For example, as private sector investors go in ‘search of yield’, assets such as contingent convertible bonds that banks use as part of their capital structure, will become less expensive.
However, quantitative easing is unlikely to have much of an effect on countries where there is a low demand for credit or where economic growth remains sclerotic. S&P says it intends to monitor whether an abundance of cheap liquidity will lead to banks’ lending to more risky sectors.
The agency adds that it does not expect to see a widespread distortion of credit pricing dynamics, “however, we see the potential for banks to become more complacent than when resources are scare and costly”.
The other main concern that S&P has about the effects of quantitative easing is that it could once again lead to macroeconomic imbalances throughout the eurozone.
The huge amount of liquidity in the system could inflate bubbles in asset classes such as property and equities.
“However, in countries such as Ireland and Spain, which have huge debt overhangs, then quantitative easing could provide a cushion against the deleveraging process,” it added.
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