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Quarterly Outlook
Europe is getting ready for green QE
Christopher Dembik
Head of Macroeconomic Research
Summary: Based on a strict interpretation of the Treaty, the ECB can play a role to protect the environment
Are Australia’s fires our global wake-up call? This is a legitimate question considering the devastating impact of the natural disaster happening in Australia. As we enter a new decade, there is no debate that there are more and more frequent natural disasters in the world. Based on statistics released by “Our World in data”, there have been 335 natural disasters per year over the past 20 years, which is twice as frequent as 1985 to 1995. At the same time, the economic cost is quickly increasing. It reached $200 billion per year on average over the past ten years, which is four times more than in the 1980s.
Change is coming from society and that is ultimately influencing politicians’ choices. The need for climate adaptations is reshaping the political landscape in Europe. Austria’s new government — a Conservative-Green coalition — is the first of many to come, and we would not be surprised if a Green-CDU/CSU coalition rises to power in Germany following the 2021 election. We think that Germany turning green will be the main political gamechanger in the coming years.
Climate consciousness is fueling public acceptance for more active fiscal and monetary policy. The speed of adjustment remains uncertain, but it has already influenced investors’ behavior. Over the course of the current economic cycle, fossil fuels sectors have significantly suffered. Looking at Europe, since 2008, the Europe STOXX 600 Oil & Gas index has dropped 25% versus the 14% rise seen in the STOXX 600.
The slump is even bigger in the United States. Over the same period, the Dow Jones Coal Index decreased by 95% while the benchmark index skyrocketed by 120%. Of course, not all of this evolution can be only attributed to the rise of green capitalism — but it has certainly played a key role.
In our view, the next step will be the implementation of a massive monetary and fiscal climate package, but that is more likely in 2021 than 2020. Over the past months, most central banks have pointed out the importance of climate change, such as the Bank of England which has warned of “a climate Minsky moment”.
The ECB is also embracing this issue. We believe the review of the framework that is about to start will be the best opportunity to include climate change. In her most recent letter to the EP, ECB Lagarde clearly stated her intentions: “the intended review of the ECB’s monetary policy strategy…will constitute an opportunity to reflect on how to address sustainability considerations within our monetary policy framework”.
There is already an emerging debate on whether climate change should be part of the ECB’s mandate. If we rely on the Treaty, the primary objective is defined as price stability. However, it also mentions that “without prejudice to the objective of price stability, the European System of Central Banks shall also support the general economic policies in the Union with a view to contributing to the achievements of the objectives of the Union”. Among these objectives, it is specifically stated that Union policy prioritises a high-quality environment (Article 3 (3) of the Treaty on the European Union).
Based on a strict interpretation of the Treaty, the ECB can play a role to protect the environment — for instance by launching a green QE — as long as it does not enter into conflict with the primary objective of price stability. Considering the level of realised inflation and the level of expected inflation in the euro area, it is very unlikely that the risk of potentially conflicting goals will be raised anytime soon.
However, green QE from the ECB is not going to save the planet and decarbonise the economy by itself. The ECB has mostly three options to launch green QE:
- Favouring green bonds as part of the revived QE programme. But there is just not enough issuance out there yet.
- Applying a punitive “haircut” to bank collateral assorted to high carbon intensity activities. But this will further weaken the European banking sector.
- Targeting transition bonds for dirty companies that try to become greener. But this raises concerns among climate activists.
Contrary to what has happened over the past 10 years, central banks cannot be the only player in town to fight climate change. Governments will need to step in —and the current evolution of the yield curve is creating a very attractive environment for fiscal stimulus oriented to fund green projects.