Saturday 24 February 2018

And the bond played on: ECB won't set an end date for QE policy

Janet Yellen, chair of the US Federal Reserve, speaks with Mario Draghi, president of the European Central Bank, before a G7 meeting last year
Janet Yellen, chair of the US Federal Reserve, speaks with Mario Draghi, president of the European Central Bank, before a G7 meeting last year

Francesco Canepa

THE European Central Bank (ECB) is keen to keep its quantitative-easing (QE) asset purchases open-ended, rather than setting a potentially distant date on which bond-buying will stop, three sources familiar with the discussion have said.

Ending the vast bond-buying programme would help normalise monetary policy, but threatens to unnerve markets that have come to rely on the resulting cheap credit. By not saying when its net bond purchases will fall to zero, the ECB hopes to underline that there is no preset course for its stimulus programme, the sources added.

They held up the exit by the Federal Reserve - headed by Janet Yellen - from its asset-buying in 2014 as a potential blueprint, noting the US central bank's unwillingness to publicly target an end date.

"The Fed has done the most successful exit, so it's the example for us to study," said a source who asked not to be named. "The important thing is not to pre-commit and to keep it very gradual."

ECB president Mario Draghi sent a shockwave through markets earlier this month when he opened the door to potential tweaks to the QE programme. That left investors scrutinising any potential clues to the bank's next move, which is expected to come at its September 7 meeting. ECB policymakers also meet next Thursday.

Half of analysts polled by Reuters now expect the ECB to announce in September that it will gradually wind down its asset buying, a process known as tapering, while a quarter see a one-off reduction and another quarter expect no change.

So far, the ECB has said its purchases are intended to run at their current pace until December 2017 "or beyond, if necessary" and that there would be winding-down phase after that.

The biggest challenge could be convincing markets that tapering, once started, may still be subject to change.

While the Fed emphasised the open-ended nature of its bond purchases, it scaled back the amount it bought by $10bn at each meeting, creating the perception it was on a preset course even if that notion was taboo.

The Fed announced its first reduction in December 2013 and ended buys the following October. Its policymakers keenly avoided the discussion of an end-date throughout the tapering process, even if markets inferred it and were eventually proven right.

The sources noted that adopting a similar strategy risked entrapping the ECB by making it difficult to deviate from a presumed schedule without generating undue market volatility.

The ECB declined to comment. The sources added that no decision has been made and the debate remains open, with new staff forecasts due in September expected to provide a key piece of the puzzle.

"How can I decide in September what we're going to do next June?" another source said. "It's got to be data-dependent and we need to preserve the flexibility."

Of particular importance for policymakers will be German wage negotiations around the start of next year and they are keen to have flexibility to respond, particularly if the results again disappoint.

While growth is accelerating and unemployment is falling quicker than expected, wage growth is anaemic, partly because unions tend to look at past inflation when tabling demands, making it difficult to escape a low inflation environment.

"Next year's German wage deals will be very important," a third source said. "I think unions are not aggressive enough in making their demands given rising corporate profitability."

The ECB's problem is that even as Eurozone economic growth is on its best run in a decade, inflation is expected to remain weak, and well short of the ECB's target of almost 2pc, at least through 2019.

In a possible clue about the sort of move the ECB may contemplate, Executive Board member Benoit Coeure pointed to the bank's decision last December when it cut its asset buys by a quarter but extended the timetable by nine months.

"We scaled back our asset purchases without undermining the support given to the economy," Coeure said in a recent interview. "So, I would argue that we have already adjusted our monetary policy ... This adjustment has been done in a very careful way, as a number of factors continue to weigh on inflation."

If the ECB is confident its previous move was correct, it may again consider a one-off reduction with a term extension before revisiting the subject later.

Draghi argued earlier this month that with growth alone providing more accommodation, the ECB could tighten policy to keep the broad level of stimulus unchanged. (Reuters)

Key comments by ECB Governing Council members ahead of next Thursday's interest rate meeting:

"As the economy continues to recover, a constant policy stance will become more accommodative, and the central bank can accompany the recovery by adjusting the parameters of its policy instruments - not in order to tighten the policy stance, but to keep it broadly unchanged. Any adjustments to our stance have to be made gradually, and only when the improving dynamics that justify them appear sufficiently secure. While there are still factors that are weighing on the path of inflation, at present they are mainly temporary factors that typically the central bank can look through."

- Mario Draghi, ECB president, June 27

"Maintaining a steady hand continues to be critical to fostering a durable convergence of inflation toward our monetary policy aim.

We need to be persistent, because the baseline scenario for inflation going forward remains crucially contingent on very easy financing conditions which, to a large extent, depend on the current accommodative monetary policy stance. As the economic prospects brighten, higher expected returns on business investment will make borrowing conditions increasingly attractive."

- Peter Praet, chief economist, July 6

"The increase in long-term interest rates is the result of consolidating growth. Governments and financial players must prepare themselves for it. As early as last December, we scaled back our asset purchases without undermining the support given to the economy. So, I would argue that we have already adjusted our monetary policy - made possible by the continued improvement in the economic situation."

- Benoit Coeure, executive board member, July 7

"Although inflation is not yet on a stable path towards our objective, all the conditions are in place. It is just a question of time and patience."

- Sabine Lautenschlaeger, executive board member, June 30

Irish Independent

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