COLUMN-ECB launches QE with trailing wind: James Saft

(James Saft is a Reuters columnist. The opinions expressed are his own)

By James Saft

March 10 (Reuters) - The European Central Bank is about to discover that for once, by launching a bond-buying campaign just as credit conditions improve, it is getting lucky.

That the central bank commences quantitative easing as the Federal Reserve awakes, stretches and prepares to raise U.S. interest rates will also help by sharpening the contrast between the strong dollar and what is likely to be a weakening euro.

The ECB began buying up government bonds on Monday under a plan to fight deflation and slow growth by injecting more than 1 trillion euros into the euro zone over the next year and a half.

Announced in January, the plan is getting a magnifying effect, not simply because private investors are reacting to ECB purchases by taking on more economy-stimulating risk, but also because the euro zone's true engine of growth, its credit system, is playing along.

"Record (LSE: REC.L - news) lows in financing costs, the gradual turn in the credit cycle, the largely successful conclusion of the stress-test exercise and the ongoing repair of bank balance sheets indicate that the more aggressive ECB policy will gradually reach the real economy over time," Holger Schmieding, economist at Berenberg Bank, wrote in a note to clients.

The rap on QE, and it is in part fair, is that its impact isn't felt sufficiently in the real economy. QE acts by tempting investors to take on more risk, which can make credit more easily available and also drives up the value of financial assets. The further plan is that once stocks and bonds rise, investors spend a bit of the extra money, thereby helping money to move around the economy and stimulate growth.

While this might make for more buyers of gold Apple (NasdaqGS: AAPL - news) watches, the benefits further down the economic scale are under question.

In theory this is especially true in Europe, which has a less well developed capital market creating bonds in reaction to QE-driven appetite and is more dependent on old-fashioned bank lending.

That makes a recent run of strong data showing faster movement of money and credit around the euro zone economy particularly encouraging. As a result not only are the prospects for the euro zone better than otherwise, but also the effects of QE will be felt more at the roots rather than soaking the surface and running off downhill into investors' portfolios.

A LITTLE LOCAL DIFFICULTY

To be sure, dangers remain in the euro zone. While issues surrounding Greece and its debt feel contained, they still have the power to drive up the cost of finance for weaker euro zone sovereign borrowers. And though euro zone banks still have considerable work to do to rebuild capital, last week's announcement by the European Banking Authority that it would hold no zone-wide stress test this year was an acknowledgement of progress made.

Loans to the private sector in the euro zone, adjusted for sales and securitizations, grew by half a percent in January from a year earlier, accelerating from a 0.2 percent year-on-year gain in December. Lending to households grew while lending to business slowed its pace of decline.

That accords with the ECB's January survey of bank lending which showed banks easing terms and seeing increased demand for loans.

Even better is recent data about monetary movement around the economy, which showed the amount of euro zone money in circulation and on overnight deposit rose at a 9 percent annual clip in January, the fastest since 2011.

Add in the impact of QE, which may be modest, and things look much less dire than they did last year. QE works best as an accelerant rather than as an engine.

One issue for the ECB will be what, exactly, it can find to buy. Roughly half of euro zone sovereign debt trades at negative yields and ECB bond buys will outpace net new supply by a ratio of three to one, according to Barclays Bank calculations.

One clear impact will be continued pressure on the euro, a welcome development for the ECB as it lessens deflationary pressure and makes euro zone exports more competitive.

The euro on Monday hit its lowest against the dollar since 2003 at $1.0821. Last week's U.S. jobs data pointed to the likelihood that the Federal Reserve will indicate at its meeting next week that 'patience' is no longer warranted and a rate hike is coming up in June or July.

Don't expect any sharp change of stance from the ECB.

The euro zone is an economy in need of a lot of lucky breaks which for once appears to be getting them. (At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com and find more columns at http://blogs.reuters.com/james-saft) (Editing by James Dalgleish)