THE launch of eurozone quantitative easing less than four weeks ago was a remarkable moment in financial history. Not only did the European Central Bank shed its conservative image and defy Germany’s Bundesbank, but unlike with earlier US Federal Reserve QE, its €60bn-a-month programme of public and private asset purchases started when stock markets were testing record highs and it seemed interest rates could fall no further.

For watchers — and nervous bystanders — here is a guide to what we have learnt and what might happen next. One lesson is that Mario Draghi, ECB president, is either lucky or has great timing.

As bond buying started, the eurozone economy flickered back to life. Economic confidence has jumped to a near-four-year high; the main eurozone purchasing managers’ index — a gauge of economic activity — has risen for four consecutive months.

Economists debate exactly how QE stimulates economies. Perhaps one way is via a “confidence channel”: if enough people believe QE works, it works. So far Mr Draghi has managed to pull off that trick; eurozone share prices are up 16pc this year, a decent QE pop by Fed standards. “The magic has worked in a way,” Vincent Juvyns, strategist at JPMorgan Asset Management, says.

Helping Mr Draghi has been the euro’s steep fall against the dollar, the result of diverging eurozone and US monetary policies. Again, Mr Draghi got his timing right.

In spite of an appreciating currency, the Fed should still increase interest rates this year, possibly in June. Meanwhile, with a stronger currency crimping US companies’ earnings, Europe looks attractive to US investors. Hence the rush into eurozone equities.

But the experience of eurozone QE has not been smooth for the rest of continental Europe. Switzerland’s economy was jolted by a jump in the Swiss franc after the country’s central bank gave up trying to cap its value against the euro.

Sweden and Denmark have had to cut interest rates deep into negative territory to prevent side-effects.

Meanwhile, transatlantic policy divergence has complicated life for strategists trying to predict where yields are heading next.

“It’s like the end of the cold war, when you moved from a bipolar to a multipolar world, with central banks tugging in different directions,” Richard McGuire, bond strategist at Rabobank, says.

Before the ECB started buying on March 9, many expected bond prices to fall and push up yields.

The argument was that the ECB’s intentions were well known and that smart investors “buy the rumour, sell the fact”. In fact, another lesson of eurozone QE is that yields could fall further.

The biggest declines have been in German yields. That was perhaps not surprising: Berlin’s fiscal conservatism is expected to create shortages of German debt for the ECB to buy. But bond strategists fret that liquidity constraints in short-term debt markets are distorting prices and the functioning of markets.

Corporate bond issuance has surged as companies have taken advantage of ultra-low interest rates; if proceeds fund share buybacks, as many expect, the share rally will be given further support.

Bond yields fell in spite of re-escalating worries about Greece’s future in the eurozone, though Spanish and Italian yields might have fallen further without the ructions created by the new Athens government.

Possibly, that falling yield trend could soon reverse, and not necessarily smoothly. The ECB launched QE to pull the eurozone from the brink of a deflationary slump.

If inflation rises, so should bond yields, which compensate investors for the erosion of their purchasing power. The risk is of a disruptive sell-off, perhaps triggered by a sudden change in expectations about future inflation rates.

A final lesson of eurozone QE is that even when central banks are writing financial history, their actions take time to feed through. It is still unclear whether Mr Draghi can avert the deflation threat; annual eurozone inflation in March was less negative than in February but below zero.

Long-term inflation expectations priced into markets have picked up only modestly. Aggressive QE launched by Haruhiko Kuroda after he became Japan’s central bank governor two years ago has failed to lift Japanese inflation decisively. Will Mr Draghi really be any luckier?

ralph.atkins@ft.com

Published in Dawn, Economic & Business, April 6th, 2015

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