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THE

EFFECT

OF

QUANTITATIVE

EASING ON IRISH BUSINESSES

Student: Daniel Flanagan
Student Number: C11419868
Student: Ben O’Connor
Student Number: 11336376
Student: Cian O’Brien
Student Number: C11398546
Student: Mark Draper
Student Number: C11421778
Student: Daniel Connell
Student Number: C11705359
Word Count:

1

Declaration
I hereby certify that this material, which I now submit for assessment as a continuous
assessment project in Financial Services on the course DT365/4 BSc (Business and
Management) Year 4, is entirely my own work and has not been submitted in whole or
in part for assessment for any academic purpose other than in fulfillment for that
stated above.
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Date:……………………

Daniel Flanagan
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Ben O’Connor
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Cian O’Brien
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Mark Draper
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Daniel Connell

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......5 EUROPE’S ADOPTION OF QUANTITATIVE EASING......................................4 WHERE HAS QUANTITATIVE EASING BEEN APPLIED BEFORE?................14 Financial Instruments.........................................14 Bonds Reduced In Value.................5 America................................................................................................................................................................................15 Lower Cost of Borrowing....................TABLE OF CONTENTS INTRODUCTION................................................................................................................................................15 RISKS..............................................15 Increased Consumer Spending.....................................................................................................................................................................................................................................................................................12 NEGATIVE EFFECTS OF LOW INTEREST RATE..............................14 POSITIVE EFFECTS OF LOW INTEREST RATE...............8 Negative Effects for Irish Businesses of a Weaker Euro...15 REACTION BY IRISH BUSINESSES TO LOW INTEREST RATES..............6 Positive Effects for Irish Businesses of a Weaker Euro..............................19 3 ..........................................................................................................................................................9 QUANTITATIVE EASING’S EFFECT ON STOCK MARKETS............4 WHAT IS QUANTITATIVE EASING?..............................................................................................................16 CONCLUSION................................6 EXCHANGE RATE MOVEMENT....................................................................................................................................................................................................5 Japan.............................................................................................................................10 EFFECT OF LOW INTEREST RATE AND INCREASED CREDIT AVAILABILITY.................................................................................................18 REFERENCES..................................5 United Kingdom..............

Quantitative easing is when the central bank produces money electronically and pumps it into the economy. WHAT IS QUANTITATIVE EASING? Quantitative easing is adopted when consumer spending is low and there are signs of deflation. The drop in return encourages investors to sell their assets and re-invest in other high return investments therefore increasing the price of these assets too (Bank of England. insurance companies. Furthermore.1 trillion in order to help Europe in the fight against increasing deflation levels and stagnant growth. 2015). it will increase the levels of cash reserves in the high street banks. For example by purchasing from high street banks. By increasing the cash reserves the high street banks will be able to lend more which will encourage customers to spend. along with the anticipated exchange and interest rate movement and their effect on Irish businesses. 2015).INTRODUCTION In January 2015. The stimulus package will run through to September 2016 in an attempt to boost inflation. Mario Draghi announced a quantitative easing package worth €1. make europe more competitive and to hopefully increse growth. thus stimulating economic growth. 4 . the effects of quantitative easing on stock markets will be reviewed along with the potential risks of implementing the quanitative easing programme. This causes long term interest rate to drop and encourages households and businesses to spend (Walker. As the bank purchases the assets the available supply drops. The central bank generally purchases government bonds from private sector firms such as high street banks. 2015). This causes the price to increase which reduces the yield thus causing returns to drop. pension funds and non-financial companies (Bank of England. The aim of quantitative easing is to reduce long term interest rates so to encourage spending (Walker. 2015). This article seeks to examine quantitative easing and its previous uses.

QE2. Since April 2013 the BOJ has acquired another ¥84 trillion worth of government bonds (Allen. United Kingdom According to Joyce (2012) there was a risk that Consumer Price Index inflation wasn’t going to reach the 2 per cent target set by the British government. 2012) and by 2010 the BOE altered their focus and purchased government bonds (Joyce. To date the FED has spent over $3 trillion on government sponsored enterprise debt. America Since the financial crisis in 2008 the Federal Reserve (FED) has practised quantitative easing four times (QE1. 2011).WHERE HAS QUANTITATIVE EASING BEEN APPLIED BEFORE? Japan Japan was the first to implement QE in 2001 because their economy was experiencing high levels of deflation. So there are no results yet whether QE has been successful for the Japanese economy. Between 2009 and 2012 the BOJ purchased ¥187 trillion worth of assets.5 per cent. Davies. Operation Twist and QE3). According to Walker (2014) America’s QE programme has reduced interest rates for households and businesses. Cai. The Bank of England focused on purchasing medium and long term government gilts (Mortimer-Lee. mortgage back debt and long term treasury debt (Fawley and Neely. 2014). 2013). 2012). According to Fawley and Neely (2013) the BOJ focused their purchasing on short and long term government bonds. 5 . The Bank of Japan decided in 2001 to launch their QE programme after their failed attempt to reduce deflation and the collapse of global IT industry (Bowman. and Kamin. helped with job creation and prevented the US slipping into another recession. According to Allen (2015) the BOE has said that QE easing has had a positive effect on increasing the price of bonds and shares along with increasing jobs. 2015). With the risk present the Bank of England’s Monetary Committee announced their QE plan to purchase assets and reduce the bank rate by 0. However according to Prof Martin Feldstein of Harvard University there is a worry that by pumping large amounts of money into an economy it can lead to higher inflation (cited in Walker.

2015). It is expected that the ECB’s QE programme will give a strong signal to the markets that they are taking action to restore inflation to 2 per cent and is also expected to cause the euro to weaken making European products cheaper on international markets (The Economist. Similarly. He clarifies that the interest rate is the mechanism responsible for causing the devaluation of a currency. Also vice versa a decrease in the euro zone’s money supply causes an appreciation of the euro. 2015). We have already seen this occur in the euro zone as the euro has fallen sharply against 6 . thereby increasing exports and boosting inflation’ (De Grauwe 2015). This invariably leads to a capital outflow which causes a depreciation of the euro. However it is not expected to have the same impact as the FED’s and the BOE’s QE programmes because the markets have been expecting the announcement for some time (The Economist. De Grauwe (2015) describes how the recently announced quantitative easing programme should have a substantial influence on the exchange rate of the euro. Krugman (2008) explains that an increase in the euro zone’s money supply causes a depreciation of the euro. 2015).However there is now a worry of deflation as inflation currently rests at 0. EUROPE’S ADOPTION OF QUANTITATIVE EASING With low economic growth and inflation dropping below zero in December 2014 the Europe Central Bank (ECB) finally announced their QE programme at the start of this year (BBC. EXCHANGE RATE MOVEMENT Mortimer-Lee (2012) clarifies that one market that is clearly distorted by quantitative easing is the foreign-exchange market. They are going to spend €50 billion a month for the next 19 months on government bonds and €10 billion on asset backed securities (The Economist. The increase in the euro zone’s money supply reduces interest rates in the euro zone therefore reducing the expected return on euro deposits. The ECB are not going to purchase Greek bonds until the Greek government reaches an agreement on the debt they owe to the other euro zone partners (RTE. 2015). He states that ‘by increasing the supply of money base the ECB will contribute to a further weakening of the euro vis-à-vis other currencies such as the dollar. 2015). 2015). the pound and the yuan.5 per cent (Allen.

2015). shedding 1. 2015). Below is a 6 a month graph of the Euro/US Dollar rate: Source: Yahoo (2015) The quantitative easing programme was announced on January 15 th of this year. However from the graph above it can be seen that market participants reacted prior to the announcement. namely the dollar and the pound sterling.other currencies. A lot of resistance to the euro can be seen from early November 2014 and consistently throughout 2015 to date.5 percent to trade near $1. “The euro's unrelenting fall accelerated on Wednesday. with little or no support evident. (2015) found that there was a depreciation of the euro and an increase of its volatility before and after the ECB's announcements of the implementation of a quantitative easing programme.05 for the first time in 12 years” (Reuters. Kenourgios et al.S. Experts believe that the euro/dollar rate will move to parity by end of the year stating “U. They explain that markets were anticipating the actions of the ECB and reacted accordingly. bank Morgan Stanley has forecast that the euro will sink below parity with the dollar before the end of this year” (Reuters. 7 .

2015). Positive Effects for Irish Businesses of a Weaker Euro Labonte (2015) explains that quantitative easing encourages exchange rate depreciation that causes exports to rise and imports to fall. 8 .Source: Yahoo (2015) Similarly. Like the Euro/Dollar rate.145 pence EURGBP and an 18-month low of 128. there was strong resistance to the Euro in late November 2014 and this has continued throughout 2015. This is especially good news for Irish businesses as Ireland are an export-orientated country. the Euro/GBP (Great British Pound) rate has weakened significantly in recent months. The weaker euro should drive export-orientated growth to non-euro markets. “The Euro struck a seven-year low against sterling at 70. Our main trading partners.29 yen EURJPY” (Reuters.

He also identifies that over the past year the euro has lost approximately 24% of its value against the dollar and over 16% against sterling. This means that Irish exporters will receive a massive competitiveness boost as a direct result of the weak euro. 2015) Negative Effects for Irish Businesses of a Weaker Euro Although the weaker euro increases our competitiveness. the weaker euro may act as a stimulant for domestic growth as consumers and businesses may look to purchase indigenous goods instead of importing foreign goods.4bn. will benefit hugely from the weaker euro. Ireland exports 85% of its food to more than 160 countries worldwide and the agri-food sector accounts for more than 10% of total Irish exports (Teagasc 2015). This is positive news for smaller businesses who only operate on a domestic level.3bn while exports only totalled €13. Importers will have to give away more euros to import goods from non-euro markets. Britain accounts for 38% of exports from the agri-food sector so the weaker euro should increase agricultural exports to Britain and other non-euro markets. Strauss and Gordon (2015) explain that essentially companies with high U. Strauss and Gordon (2015) explain that low-cost airlines that buy fuel in dollars but have no dollar revenues could be among the worst affected.K. Colgan (2015) identifies the tourism sector as one that should incur substantial growth in 2015 as a result of quantitative easing. would eventually be among the biggest beneficiaries” (Strauss & Gordon. Power (2015) explains that Ireland imports more goods from Britain than they export to them. as the price of fuel will be highly inflated due to the weaker euro. and the U.S. merchandise imports from Britain totalled €17.. The Irish tourism sector should reap massive benefits from the weaker euro as British and American tourists will see this as a great time to travel to Ireland. such as pharmaceuticals. However Ryanair has stated that it has 9 . dollar revenues will gain most from the weaker euro. They state that “given the euro’s fall has been sharpest against the dollar. The weaker euro may have a negative impact on the airline industry.namely the U. According to Power (2015) 64% of our goods produced are exported to non-euro markets. companies with significant US or dollardenominated sales. Power (2015) also explains that the agri-food sector could receive a timely boost from the weaker euro.S. it will inflate the price of imports. He shows that in 2014. However.

The S&P 500 remained a bull market throughout the duration of the quantitative easing programme. 2011). Ben Bernanke. a market consisting of the top 500 companies in the U. announced a tapering back of the asset buying programme which caused significant volatility in the market.. Below is a graph of the S&P 500. Inevitably. This snapshot shows a 5 year period immediately after the Federal Reserve’s announcement a quantitative easing programme in late 2009.locked in its capital-expenditure requirements through September 2017 at a rate of $1. It can be seen here that there was substantial support in the market for equities and therefore share prices soared. This because Ireland are an export orientated economy. “With government debt now carrying a negative yield thanks to QE. Overall. This will put further upward pressure on equity prices” (Joyce et al. Investors will have to move higher up the risk curve to get a satisfactory return. Larger multinational companies who operate in non-euro markets will reap the most benefits. the additional compensation investor’s demand for the risk of holding equities (the so-called equity risk premium) should fall. yields on such bonds will decline forcing investors to look elsewhere for higher returns. This means bond investors will look to equities for higher yields and therefore stock markets will appreciate in value as a result of this. “As investors attempt to rebalance their portfolios away from gilts towards more risky assets.S. it’s no surprise that investors are throwing themselves headlong into equities to try and find some income” (Hunter and Chisholm. most Irish business should benefit from quantitative easing. QUANTITATIVE EASING’S EFFECT ON STOCK MARKETS As quantitative easing involves a massive bond-buying programme. Quantitative easing and stock markets are said to have a positive correlation. 10 . There were minor blips as you can see a strong resistance in the market in mid-2011 when the then head of the Federal Reserve.35 to the euro and is nearly fully hedged for all of its fuel requirements. 2015). the devaluation of the euro as a result of the recently announced quantitative easing programme should act as a stimulant for growth by increasing our competitiveness on a global stage. whilst smaller scale exporters and other businesses should also benefit.

to push up asset prices” (Fukui. for example.The programme is designed to boost investor activity and consumption within economies and the U. given the stellar performance of US shares in recent years when the Federal Reserve was the largest buyer of government debt. The ISEQ index of Irish shares has become a bull market. seeing huge support in recent months. 2003) Although it is early days yet as regards Europe’s quantitative easing programme. investors are mindful that the eurozone equity rally has further room to run. acting. “The aim of this process was thus to generate positive economic momentum. Below is a chart of the ISEQ’s progress in the last 6 months: 11 . Irish stocks have already soared on the back of the announcement. Hunter and Chisholm (2015) clarify that with the ECB’s €60 billion of monthly bond purchases starting only last month.S. programme implemented by Ben Bernanke seems to have done just that.

A business will now have to enter into riskier investments in order to achieve the same 12 . it can be seen that publicly traded companies gain more financial reward from a quantitative easing programme as empirical evidence shows that markets appreciate in value on the back of a quantitative easing programme. This means that businesses with cash deposits will get lower returns on its money than previously thought. This leaves a number of options for businesses.From this evidence. EFFECT OF LOW INTEREST RATE AND INCREASED CREDIT AVAILABILITY One effect of introducing QE is that interest rates remain at extremely low levels. It can clearly be seen here that Irish shares have already reacted bullishly as investors look to the stock market for higher yields.

As outlined in the graphs below the ECB marginal lending rate and the 10-year government bond yield rates are at historically low rates. Source: CSO (2015) 13 .return on its cash deposits.

The low bond yields induced by QE effects businesses as it poses an asset allocation problem to pension and fund managers. therefore giving Irish businesses less return through interest. 14 . but now with yields approaching negative these funds have to be allocated elsewhere (Deloitte. 2015). Bonds Reduced In Value The yield on bonds is at such a level that the real return created through the interest rate is actually negative (Deloitte. Money market instruments which involve calculations based on deposit interest rates will now be changed due to QE lowering the deposit rate in banks. Previously a certain amount of a fund would be allocated to bonds as they were a safe asset with predictable returns.Source: CSO (2015) Negative Effects of Low Interest Rate Financial Instruments Financial instruments in which a business may have used that depend on a deposit rate will now have to revalued downwards as they will not get the same return for its bank deposits. 2015).

Wyplosz (2014) therefore thinks that businesses will not react to low interest rates by increasing spending as they are still in a period of 15 . This could act as a catalyst for Irish business to expand and increase capital expenditure through the use of extremely low interest rates. it is a supply side issue of funds. Businesses instead are looking to repair its balance sheet. 2014). Due to the lower interest rates in combination with lending becoming more accessible to consumers. This means that it’s easier for an Irish business to gain access to funds in a liquid market. Increased Consumer Spending Due to a lower return from deposits in banks for households this could positively affect Irish businesses due to increased consumption in the Irish economy. Further with the ECB purchasing bonds from the government. The ECB takes a view that there is a liquidity problem in the market i. Reaction By Irish Businesses To Low Interest Rates The thinking behind the large QE package is that the low interest rates will encourage companies to start investing and spending more in economies due to the ease of access to credit and the historically low interest rates. The hope of this cash injection into the European economy by the ECB is that it will increase consumer spending. and therefore low interest rates is increase borrowing. spending could be seen to increase if you are of the view that the reason for low consumption in the marketplace is a supply side issue. They argue that due to this deleveraging cycle.Positive Effects of Low Interest Rate Lower Cost of Borrowing One positive effect of having a low interest rate for Irish businesses is that the cost of borrowing is also lower.e. as there is a debt overhang from the recession (Lo and Rogoff. but according to Wyplosz (2014) it is a demand side issue. There is considerable debate amongst academics whether this is the case. The assumed manner that businesses will react to the QE. Lo and Rogoff (2014) and PasaniFerry and Jean (2013) are of the view that companies are deleveraging after a period of high leveraging. There is considerable debate to this view though among economists. businesses are not looking to expand and take advantage of the low interest rates resulting from a QE programme. and if banks choose to sell its bonds they will have more cash to lend out.

as they are obliged to hit certain levels of inflation which are seen as being modest. what problem will they face with QE? The answer is none. but instead are looking to repair their balance sheet after it was severely damaged during the recession. The ECB in comparisons to the US and Japan are unique as they operate a single monetary policy over eighteen different economies within the Eurozone. QE is essentially tailor-made to suit an economy that is experiencing challenges. fearing an increase in interest rates in the future.recovery in which the phrase has been coined a ‘balance sheet recession’ by Richard Koo. This is where businesses are not looking to maximise their profits. so the risks haven’t been observed to the level they should be. and they are a wonderful example as learning by doing (Blinder. when inflation levels get unsustainable. Businesses may look to capitalise on the low interest rates resulting from the QE programme and spend money now. seeing this occur only a few years ago will lead to major worries for Irish businesses (Lyonnet & Werner. A peculiar risk for the Irish economy to take in to account is that QE might work too well. Quantitative Easing has only been around for a very short period of time. A major risk for the growing Irish economy at this moment in time is the danger of a double dip recession. but is still a major risk. This led the UK economy into a double dip recession in 2012. given the disagreement going on amid academics whether or not this will mean that Irish businesses will truly benefit from the low interest rates and increase spending. So with regards the Central Bank. This occurred in England in the back end of 2011 due to bank credit growth contracting by record amounts. 2012). However. 2015). Irish businesses may simply go on and continue to repair their balance sheets and not look to maximise profits. When the US began QE it was crisis driven but as time passed it became orderly and thought-out. For instance it is difficult for the central bank to judge whether or not 16 . 2015). The growth of the central bank’s balance sheet will become an issue if a T Bill defaults which is unlikely to happen. there must be a downside too. 2010). It is difficult to say for certain. the central bank will need to tighten monetary policy (Deloitte. which all have their own distinct challenges (Deloitte. RISKS Where there is an upside with regards to QE.

2015). and directly because it increases global commodity demand by making dollar priced commodities cheaper in the rest of the world” (2011. Quantitative easing also forces investors to move into riskier investments.they are using the right amount of QE. As Ireland is a part of the Eurozone. 2012). It might be for the reason they feel the need to exit QE at a certain time and the ECB don’t deem it appropriate at that moment in time to leave QE behind (Mortimer-Lee. along with the cost of exporting goods rising significantly too. 2012). there might be conflicting objectives between the Irish central bank and the ECB. Nonetheless one of the biggest risks that might come with QE that will affect businesses in Ireland is that commodity prices might increase to unsustainable levels. This would have a huge effect on Irish businesses as the cost of transport will rise considerably. With Ireland after going through one of its worst ever recessions and housing crisis in its history. 17 . If inflation becomes too low or even worse outright deflation occurs. If the size of QE is not correct. 2015). If this transpires the Irish economy will be back where it was seven years ago. companies’ profits will be cut. corporate borrowings and government re-financing would be liable to confine growth (Quantitative easing: Implications for bond market volatility. there is a threat of the central bank providing too much stimulus meaning the economy could grow at a faster rate than it should be (Mortimer-Lee. According to Palley the “Dollar exchange rate depreciation increases commodity prices indirectly via the expected inflation effect. p12). Mr. As stated in the New York Times. This is highly likely to occur between one of the eighteen economies within the Eurozone (Deloitte. Draghi’s only objective officially is to drive inflation towards the central banks goal of below 2 percent. If this emerges it might put ideas into other central banks minds and the whole programme could all go into disarray as one economy can create a domino effect for others to follow. the consequences on mortgages. With this materialising another recession could be on the cards for Ireland (ECR Research. QE may add to the woes of the past. 2015). If this volatility is to occur. As it signifies substantial risk to the stability of the bond market and brings about volatility. 2012). wages will decrease and unemployment will rise significantly (Ewing.

Also there is a chance that QE could create bubble like conditions if too much stmulus is pumped into Europe. Early signals are positive but the programme has only just begun. although it will also negatively inflate the price of all imports. The impact of quantitative easing should have many positive effects for Irish businesses. However this may also be deemed positive. Ireland needs to be particularly careful of ths 18 . however this programme does not come without its risks. The above article has analysed the positive effects of the stimulus programme on Irish businesses. along with potential negative efects and associated risks. Investors may look to equities. However. As stock markets continue to appreciate in value and investement rises this may increase consumer confidence and finally lead to Ireland and Europe creating sustainable growth. The programme is being implemented across 18 different econmoies which will provide their own distinct challenges. the asset buying programme has provided banks with more money available to lend. The weaker euro has lead to a massive increase in competitiveness for Irish exporters. as it may act as a stimulant for domestic growth. Similarly. hence stimulating growth in the economy through the circulation of money and increased consumption. particularly for small Irish businesses. this has increased the money supply within the european economy and provides governments with more money to spend on both the private and public sector. The QE annoncement has encouraged exchange rate depreciation which is especially good news for Irish businesses as Ireland are an export oriented country. as a result of the major debt overhang from the recession it may be feared that banks may not be willing to lend or companies are not looking to expand and take advantage of low interest rate but instead seek to deleverage balance sheets.CONCLUSION The major quantitative easing package annonced January 2015 has been implemented in order to stimulate growth in the eurozone economy. The quantitative easing has also negatively effected the yields on government bonds which has forced investors to move higher up the risk curve in order to increase returns. corporate bonds or property for the higher yield they require. As the ECB have committed to the mass purchase of eurozone government bonds. which may act as a catalyst for Irish businesses to expand and increase capital expenditure on the back of lower borrowing rates.

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