WHAT'S GOING TO BE THE ECB NEXT MOVE?

The European Central Bank (ECB) signals an increasing readiness to pursue a big programme of quantitative easing (QE)—creating money to buy financial assets—in order to lift worryingly low inflation. Such an undertaking would require the purchase of sovereign bonds, an unpalatable policy in Germany, the country that in effect underwrites the single currency. Will the ECB nonetheless move from semaphore to action when its governing council meets on January 22nd?

Mario Draghi, the ECB’s president, wants to crank up monetary policy because inflation remains uncomfortably lower than the bank’s goal of almost 2%. The headline rate stayed below 1% throughout 2014, reaching 0.3% in November, while the core rate, which strips out food and energy prices, was just 0.7% in late 2014 . The steep fall in oil prices will be a welcome tonic for the sickly euro-zone economy. But it may have a sting in the tail if people expect lower inflation as cheaper energy pushes the headline rate into negative territory, even if only temporarily.

A prolonged spell of “lowflation” is bad for the euro area because many of its Member States are weighed down by excessive public and private debt. If outright deflation were to take grip it would harm borrowers: when prices fall the real burden of debt, which is generally fixed in nominal terms, increases. But even if lowflation were merely to persist, this would also hurt them since the incomes that service their debt are rising more slowly than they expected when they took out the loans.

Mindful of German objections to purchasing sovereign debt, the ECB has already started down this path by buying two kinds of private-sector assets in late 2014: covered bonds (debt issued by banks that is backed by safe loans) and asset-backed securities. But neither type is big enough for such purchases to have much traction. By late December, the ECB had bought just over €30 billion, overwhelmingly in covered bonds; if sustained, this might add up to €200 billion to the ECB’s balance-sheet by the end of 2015.

Another form of private asset that the bank could purchase is corporate bonds, but the ECB would be hard-pressed to buy more than around €100 billion a year, still leaving it a long way from its goal. The only sure way to raise its balance-sheet over a realistic horizon is to buy public debt, the only asset class big enough for purchases on an industrial scale. Sovereign bonds that are eligible for banks to use as collateral against their borrowing from the ECB amounted to €6.6 trillion in the third quarter of 2014. There is ample precedent, too: purchasing public debt is the main way that QE has been conducted in America, Britain and Japan.

The ECB is permitted to buy sovereign bonds in secondary markets. But unlike other central banks it lacks a state. The credit ratings of the countries in the euro area vary from AAA in Germany to junk in Greece. Buying Greek debt would expose the central bank to potential losses if Greek politics sour further. A majority of the 25-strong council (which will share 21 votes under a complex system of voting rotation that starts in 2015 following Lithuania’s accession) would back Mr Draghi in moving to QE, but such a controversial policy might backfire if it does not command sufficient support.

Concerns about the legitimacy of QE may be allayed by an opinion from a senior legal official of the European Court of Justice on 14 January about the legality of the bond-buying commitment that gave teeth to Mr Draghi’s pledge in July 2012 to do “whatever it takes” to save the euro. Some analysts think that may be sufficient for the ECB council to press the QE button later this month. Alternatively it may wait until its second meeting of 2015, in March, especially if this gives Mr Draghi an opportunity to peel away German allies. Any announcement of a sovereign-debt-buying programme is unlikely to go beyond €500 billion. Whether that will be sufficient to drag the euro area out of its sorry state of sluggish growth and lowflation is another matter.