It goes without saying that the ECB and the Fed have received their fair share of attention in September. Each central bank has endured an alarming amount of criticism from the "stop printing money" camp. On the other hand, there are those who praise Mario Draghi and Ben Bernanke for taking bold, unprecedented policy action in order to avert the breakup of the eurozone and a slide back into recession in the U.S.
In the wake of Draghi's announcement of the new Outright Monetary Transactions (OMT) program and Bernanke's unveiling of QE3 it is important that investors have some perspective as to how the two central banks' balance sheets have grown over the course of the financial crisis and the European debt crisis (i.e. over the last 5 or so years).
Given the differing nature of what the two central banks are trying to accomplish, and given the absolute size of the two central banks' balance sheets, it would be easy to infer that the ECB runs a greater risk of stoking inflation expectations than the Fed. I am speaking here of the average person's perceptions, not of analyst opinions formed from extensive research.
If you look at the situation from the point of view of the outside observer, the ECB is attempting to stave-off the collapse of two rather large countries (Spain and Italy) by purchasing an unlimited amount of sovereign debt in the secondary market. By contrast, the Fed's objective sounds rather limited in scope and mundane in nature: essentially it is trying to bring unemployment down by 1.1% by purchasing $40 billion in MBS per month. Add to this the fact that the ECB's balance sheet is around $3.9 trillion while the Fed's is "only" $2.8 trillion and to the uninitiated, it sounds as though the potential for runaway inflation and excessive balance sheet expansion is greater in the eurozone than in the U.S.
It is interesting however, to look at how the two central banks' balance sheets have expanded over the last five years (i.e. in response to the financial and debt crises). In a "Focus Europe" note dated August 31, Deutsche Bank notes that when August 2007 is set to 100, the ECB has actually expanded its balance sheet far less than the Fed, the Bank of England, and the Swiss National Bank:
Given this, consider the following graphic which shows the total amount of Italian and Spanish government debt maturing before 2015 (i.e. sovereign debt eligible for the OMT program):
Source: DeutscheBank, Bloomberg
According to Deutsche Bank then, the ECB could
"...buy all Spanish and Italian bonds maturing before end 2015 [and its] balance sheet would still not have increased as much as [the] Fed"
Despite this it is worth noting that inflation in the eurozone is running ahead of the ECB's preferred level (2.6% versus a shade below 2%) and professional forecasters' eurozone inflation expectations are rising:
Source: DeutscheBank, ECB
As I noted before, any inability to sterilize sovereign debt purchases could cause inflation expectations to rise even if sterilization is largely symbolic, or, in Deutsche Bank's words, "more about signaling."
Ultimately, this shows that the Fed's response to the crisis in terms of balance sheet expansion has been far more pronounced than the ECB's. Taking QE3 into consideration, it would seem that investors may be warranted in being more concerned about rising prices and a falling dollar (UUP) in the U.S. than a falling euro (FXE). All the same, the prospects for both these currencies in terms of their purchasing power going forward appear grim.