ECB has its eyes wide open

THE European Central Bank (ECB) is well aware that, through its quantitative easing (QE) programme, it is taking large risks with the functioning of capital markets and economies. It recognises the institutional shortcomings of the euro area and of its members' governments, in particular their inability to make reforms - and this is the main factor forcing the ECB into action. Unfortunately, a vicious circle is at work here. The QE programme and the fall in interest rates in its wake may hold back reform efforts. Yet continuing failure on this front would make structural differences between member countries ever wider. This would make it even harder for unitary monetary policy to function effectively - which would call into question the reason for the euro bloc's existence.

The ECB is doing its best to fulfil its mandate in an inadequate institutional framework. Many on the ECB's governing council believe that resolve is needed to secure the single currency's long-term survival. Should positive growth effects fail to materialise, and euro members' divergences widen, the responsibility will lie not with the ECB but with national governments that are neither willing nor adequately able to adjust their economic policies.

The ECB is aiming to buy 60 billion euros (S$89.8 billion) of bonds every month, more than 40 billion euros in euro area sovereign bonds. German government securities make up around 25 per cent of the planned bond purchases. The ECB appears prepared to pay a high price. Mario Draghi, the ECB president, has announced that central banks will buy bonds yielding above the bank's deposit rate of -0.2 per cent. It is unusual for a buyer to state both its target quantity and maximum price in advance. There is no reason why potential sellers should sell the ECB bonds below this ceiling price, at least for markets where available volume is small in relation to the additional demand.