ECB to end bond buys as crisis policies wind down
Bank signals it won’t raise rates before next summer, suggesting gap with Fed will widen
RIGA, LATVIA— The European Central Bank is closing a chapter on one controversial policy, government bond purchases, while extending the life of another: negative interest rates.
The central bank Thursday laid out plans to wind down its giant bond-buying program by the end of this year, but said it likely would wait “at least through the summer of 2019” before raising its deposit rate, now at minus 0.4 per cent.
The ECB’s decision to start phasing out some of its easymoney policies — a day after the U.S. Federal Reserve raised its benchmark interest rate and signalled two more increases this year — comes despite mounting evidence that the eurozone economy is slowing, amid threats ranging from international trade conflicts to political turbulence in Italy.
The ECB is seeking to tread a careful path between ending a contentious stimulus policy that is close to being exhausted under its current rules while stifling any sharp appreciation of the euro and eurozone bond yields that might result.
In that, the ECB was largely successful Thursday. Investors appeared to largely interpret the bank’s moves as cautious, focusing in particular on the expectation that interest rates won’t rise before September 2019. The ECB “has done everything it can to prevent investors from pricing in rising interest rates,” said Joerg Kraemer, chief economist at Commerzbank in Frankfurt. “There is no sign of a real rate hike cycle.”
The euro fell sharply against the dollar, to $1.1647 (U.S.) from $1.1816, while yields on 10-year German government bonds dropped to 0.423 per cent from 0.494 per cent. Yields move inversely to prices.
Stocks perked up, with the Euro Stoxx 50 index rising 1.1 per cent and Germany’s exportheavy DAX climbing 1.5 per cent. Eurozone bank shares — which tend to climb as interest rates rise — fell 0.4 per cent.
At a press conference, ECB President Mario Draghi justified the decisions by pointing to robust underlying growth and a recent rebound in inflation and wages across the currency area.
ECB policy makers “concluded that progress toward a sustained adjustment in inflation has been substantial so far,” Mr. Draghi said. He was cautious on the outlook for the economy, however, stressing that the bank didn’t want to “underplay the existing risks” and that the ECB’s policies could change if the outlook darkens.
The bank lowered its forecast for 2018 gross domestic product growth to 2.1 per cent, from 2.4 per cent, but raised its inflation projections for this year and next, to 1.7 per cent — not far from the ECB’s target of just below 2 per cent.
Even with Thursday’s move, the ECB lags far behind the Federal Reserve in unwinding crisis-era policies taken after the collapse of Lehman Brothers one decade ago.
On Wednesday, the Fed raised its policy rate one quarter percentage point to a range between 1.75 per cent and 2 per cent, amid rising inflation and the lowest U.S. jobless rate in nearly two decades.
In contrast, the ECB kept its deposit rate unchanged at minus 0.4 per cent. That indicates that the policy gap between the world’s two biggest central banks will widen further.
In its statement, the ECB said it expected to reduce its bond purchases — due to run at 30 billion euros ($35.3 billion) a month through September — to 15 billion euros in October through December, when the purchases will end.
The ECB was the last of the four major developed-country central banks to engage in large-scale bond purchases, known as quantitative easing, or QE. It only launched QE in 2015, more than six years after the Fed, when policy makers feared the eurozone would fall into deflation, or a spiral of ever-lower prices.
The policy at times divided the ECB’s rate-setting committee and provoked criticism from public officials in the currency area’s biggest economy, Germany.
Thursday’s decision leaves Japan as the only major central bank with no end in sight to its purchases of bonds and other assets. The Bank of Japan meets Friday and isn’t expected to announce any policy changes.
The ECB has made up for its initial hesitance, which reflected reluctance on the part of a central bank rooted in Germany’s conservative philosophy to buy government debt. Its balance sheet has doubled since 2014, to 4.6 trillion euros, or around 43 per cent of the region’s annual economic output. The Fed currently holds assets worth around 22 per cent of the U.S. economy.
By breaking the taboo against buying bonds, Mr. Draghi, a former Bank of Italy governor, remolded the ECB in the shape of the Federal Reserve, Bank of England and other central banks that were able to respond nimbly to the financial crisis.
The ECB’s bond purchases have coincided with a period of strong economic growth. The eurozone economy outpaced the U.S. over the past two years and its unemployment rate has fallen to 8.5 per cent, the lowest level in almost a decade.
Proponents say the program has pushed away the risk of deflation and compressed interest rates for businesses and consumers, supporting borrowing and growth.
Critics argue the ECB’s pur- chases coincided with steep increases in the prices of property and other assets and made it easier for unviable “zombie” firms to stay alive. Some countries, notably Greece and Italy, still have large volumes of nonperforming loans.
Some analysts and officials argue that QE mainly worked by reducing the value of the euro against other currencies such as the dollar, thereby improving the competitiveness of eurozone businesses in international markets.
The ECB’s bond move likely will be welcomed as a necessary first step by countries in Europe that don’t use the euro, like Switzerland and Sweden, even if the guidance on rates complicates matters. Their central banks have policy rates that are even more negative than the ECB’s, and they are unlikely to raise them before the eurozone central bank does.
The ECB took a risk by pushing interest rates below zero in 2014. Crucially though, the move was supported by Deutsche Bundesbank President Jens Weidmann, a critic of some of the ECB’s other unconventional policies, including its bond purchases.
Negative interest rates tend to hurt savers and banks, but Mr. Draghi argued Thursday that savers could invest in other assets while profits at bank and insurance companies hadn’t been hurt.
The suggested timing for the ECB’s first rate increase indicates that negative rates will persist in many parts of Europe well into next year at a minimum.