Analysis of ECB's Quantitative Easing and its Effects on Inflation

This finance report examines the European Central Bank's (ECB) Quantitative Easing (QE) program, implemented to combat low inflation in the Eurozone. The report analyzes the impact of QE on inflation rates, highlighting how the ECB's actions, such as buying investment-grade debt securities, aimed to increase the money supply and lower market interest rates. It discusses the effects of rising inflation on bond prices and values, emphasizing the concerns for portfolio managers. The analysis covers the use of QE during the 2008 economic crisis and its reapplication in 2015 to address deflation risks. The report evaluates the impact of QE on bond investments, the potential for financial bubbles, and the devaluation of the Euro against the USD. It concludes with recommendations for portfolio adjustments, suggesting a shift towards European shares to capitalize on increased cash flow and improved financial positions of companies. The report emphasizes the need for careful evaluation of investments in bonds due to the rising inflation and associated risks.

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Table of Contents
Introduction:...............................................................................................................................2
Discussion:.................................................................................................................................3
Conclusion:................................................................................................................................6
Reference and Bibliography:......................................................................................................8

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Introduction:
During 2015 January, ECB embarked in Quantitative Easing or expanded asset
purchase program for reducing the negative impact from low inflation. This relevantly helped
European Central Bank to achieve their monetary objective of price stability. According to
Ecb.europa.eu (2018), year on year increase in harmonised index mainly helps in increasing
price stability, where consumer price for euro area are below 2%. The European Central Bank
conducts Quantitative Easing by buying predetermined amount of euro sovereigns and
institutions investment grade debt securities. This measure would allow European Central
Bank to increase money supply and reduce market interest rate. This relatively allows the
bank to increase their lending and introducer cheaper loans. This could allow the consumers
to spend more and business will increase their investments.
Figure 1: Inflation rate of Euro Area
(Source: Tradingeconomics.com, 2018)
The above figure mainly depicts the overall change in inflation rate of Euro area after
the implementation of Quantitative Easing by European Central Bank. The inflation was

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lagging behind, which increased after the measure and hovered around 2% inflation rate. This
raising inflation rate would negatively impact bond prices and value.
Discussion:
European Central Bank has used Quantitative Easing previously during the economic
crisis of 2008, which helped in piking up the EU economy. During 2015 the main concern
faced by European Central Bank was deflation risk and economic downturn. Hence, for
curbing the negative impact of risk Quantitative Easing is used to control the problems faced
by Euro zone. The Quantitative Easing method mainly used €1.1 trillion for easing the euro
market, where €60 billion has been used for buying treasury bonds every month. This
measure has mainly allowed European Central Bank to raise the level of monetary policy,
which could instigate their financial performance. Claeys & Leandro (2016) argued that
increment in inflation rate could raise prices of the essential goods, where it hampers
livelihood of individuals. The European Central Bank has increased the buying pressure on
Bonds and allowed banks with high liquidity, which in turn would increase low cost loans
that will be provided by banks. This might increase cash flow in the economy and boost
purchasing power of consumers. This high consumer purchasing power would increase
inflation rate and prices of the products, which could boost financial performance of
organization. In this context, Fratzscher Lo & Straub (2018) stated that rising inflation rate
would eventually allow the company to generate high revenue, as it increase prices of the
product.
This rising cash flow in the economy would eventually hamper the valuation of bond,
as rising inflation rate could nullify the actual return from investment. From the evaluation it
could be understood that inflation rate is mainly analyzed by investors to understand the
actual value of bond. Moreover, the increment in inflation rate by government intervention

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would hamper investment in bond, as it increases loss for investors. The inflation rate mainly
erodes the benefits, which is provided by bonds. Furthermore, being a fund manager rising
inflation rate would raise concern, as relevant portfolio will incur loss due to the erosion of
profits by time value of money. This would hamper profitability and return from investment
of the designed portfolio. The European bonds will be affected by the rising inflation in Euro
zone from the steps taken by European Central Bank. In this context, Braun (2016)
mentioned that after Brexit and Greece on the brink the use of quantitative measure would
allow European Central Bank to improve the deflating inflation condition. Moreover, the first
bonds that will lose value is zero coupon bonds, as value of bond will erode due to sudden
rise in inflation rate. The inflation rate before 2015 was mainly at the level of 0.61%, while it
increased to 2% in 2017. Therefore, it could be assumed that investors having investment in
bond when inflation rate of 0.61%, will lose 1.39% return in 2017 in accordance with the
rising inflation rate. This could eventually reduce the attraction of bond and force the investor
to exit the investment. However, Koijen et al., (2017) argued that bond investment during
high inflation reduces its value and attractiveness, while demand for stocks fairly increases in
the expectation of high return provided by the companies.

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Figure 2: Investment in bonds by European Central Bank
(Source: Ecb.europa.eu, 2018)
The above figure indicates the overall investments, which is been conducted by
European Central Bank. This detection of investment would eventually help in understanding
the overall cash flow from investment, which increase cash in the market and motivate
customers to spend more. The investment is mainly conducted on public sector, corporate
sector, asset-backed securities, and third covered bonds Moreover, the rigorous investment
increased inflation rate in euro area, which could increase cash flow in the market. The data
in figure 1 indicates that inflation rate was negative, which indicates reduced growth in Euro
area. However, there are negative impact from the quantitative easing used by European
Central Bank, where asset shortage, problems in structural reform and chances of financial
bubbles was identified. This relatively indicates that Quantitative Easing would eventually
raise problems for investors having portfolio consisting of both bonds and shares. The
problems faced by investor will be the declining value of bonds and chance of financial crises
due to bubble creation (Blinder et al., 2017).
The performance and evaluation of the portfolio needs to be conducted, which will be
negatively affected by rising inflation rate. The pumping of adequate capital by European
Central Bank in the eurozone would eventually increase cash flow, which will increase the
inflation rate and consumer price index. This rising inflation rate would eventually erode all
the returns that will be provided by the current portfolio, as high inflation rate would nullify
the gains obtained from investments. Therefore, adequate changes in the portfolio needs to be
conducted, where concentration on bond valuation is essential. The changing inflation rate
will negatively affect the returns provided from Bond, as it will reduce the evaluated returns
of bonds. In this context, Fawley & Neely (2013) mentioned that bonds are evaluated on

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yield, which is relatively less and can be eroded by rising inflation rate. this would decline the
actual value of the bond in few years and nullify the returns from investment. For example, if
a zero-coupon bond is bought on inflation rate 1%, whereas after sometimes if the inflation
rate Rises to 2% then the market bond value will fall increasing the losses of the investor.
Therefore, changes in Bond section of the portfolio is essential, as inflation rate is
rising. Moreover, the rising inflation rate would also raise the chances of financial bubble,
which could hamper portfolio performance. Hence, relevant evaluation of the organization
needs to be conducted, which will be or is present in the portfolio. This evaluation would
eventually help in identifying the actual financial position of the company and its value,
where inflated share prices could be ignored by the investor. On the other hand, Joyce, M.,
Miles, Scott & Vayanos (2012) argued that during the financial crisis of 2008 portfolios
having high value generating stocks and bonds had low impact from the free fall of capital
market. This indicates that using adequate measures, the rising inflation created in eurozone
could allow the portfolio to generate high returns and reduce its risk.
However, there are many negative terms, which would happen due to the rising
inflation conducted by European Central Bank. The devaluation of Euro against USD will
also be conducted, which might hamper the international currency exchange market.
Moreover, the rising inflation rate would provide consumers and companies with extra cash,
which would increase imports and strengthen the US dollar against Euro (Albu et al., 2014).
Therefore, it could be said that the measures used by European Central Bank would backfire
and increase Problems for the Euro Zone, as the currency would reduce strength against
USD.

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Conclusion:
The evaluation quantitative easing mainly indicates the problems that will be faced by
portfolio managers having stocks and born from US and Europe. The increment in inflation
rate as targeted by European Central Bank will increase problems for the bond valuation and
reduce return generation capacity of the portfolios. Moreover, being a portfolio manager
changes in European stocks and bonds need to be conducted, as increment in inflation rate
would boost share price, while decline bond value. European Central Bank uses intensive
buying of bonds, which help in increasing the cash flow of money in the economy. However,
the continuous buying of born at normal rates would raise the inflation rate and hamper
returns of those bonds. Therefore, relevant changes in portfolio needs to be conducted, where
selling of current European bonds should be instigated. This would help in reducing the
losses, which might incur due to rising inflation. Furthermore, evaluation on current shares of
European sector needs to be conducted, which might help in identifying the future growth
and profitability of the organization. Lastly, investment in European shares would be much
profitable, as European Central Bank is aiming to increase cash flow and improve financial
position of companies.

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Reference and Bibliography:
Albu, L. L., Lupu, R., Calin, A. C., & Popovici, O. C. (2014). Estimating the Impact of
Quantitative Easing on Credit Risk through an ARMA-GARCH Model. Romanian
Journal of Economic Forecasting, 17(3), 39-50.
Blinder, A. S., Ehrmann, M., de Haan, J., & Jansen, D. J. (2017). What will monetary policy
look like after the crisis?. Research Bulletin, 39.
Braun, B. (2016). Speaking to the people? Money, trust, and central bank legitimacy in the
age of quantitative easing. Review of International Political Economy, 23(6), 1064-
1092.
Bruegel.org. (2018). The European Central Bank’s quantitative easing programme: limits
and risks | Bruegel. Bruegel.org. Retrieved 14 March 2018, from
http://bruegel.org/2016/02/the-european-central-banks-quantitative-easing-
programme-limits-and-risks/
Claeys, G., & Leandro, A. (2016). The European Central Bank's quantitative easing
programme: Limits and risks (No. 2016/04). Bruegel Policy Contribution.
Ecb.europa.eu. (2018). Asset purchase programmes. European Central Bank. Retrieved 14
March 2018, from
https://www.ecb.europa.eu/mopo/implement/omt/html/index.en.html
Fawley, B. W., & Neely, C. J. (2013). Four stories of quantitative easing. Federal Reserve
Bank of St. Louis Review, 95(1), 51-88.
Fratzscher, M., Lo Duca, M., & Straub, R. (2018). On the international spillovers of US
quantitative easing. The Economic Journal, 128(608), 330-377.

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Joyce, M., Miles, D., Scott, A., & Vayanos, D. (2012). Quantitative easing and
unconventional monetary policy–an introduction. The Economic Journal, 122(564).
Koijen, R. S., Koulischer, F., Nguyen, B., & Yogo, M. (2017). Euro-area quantitative easing
and portfolio rebalancing. American Economic Review, 107(5), 621-27.
Statista.com. (2018). Inflation rate in EU and Euro area 2022 | Statistic. Statista. Retrieved
14 March 2018, from https://www.statista.com/statistics/267908/inflation-rate-in-eu-
and-euro-area/
Tradingeconomics.com. (2018). Tradingeconomics.com. Retrieved 14 March 2018, from
https://tradingeconomics.com/european-union/inflation-rate