No big bang: ECB warily starts pulling back from loose money
Interest rates to stay low for extended period of time
FRANKFURT (Reuters) – The European Central Bank on Thursday took a step toward weaning the euro zone off of loose money but promised years of stimulus and even left open the door to backtracking.
It said it would cut its bond purchases in half from January but also extend the buying program until the end of next September.
ECB President Mario Draghi said the euro-zone economy was recovering but still needed support.
“Domestic price pressures are still muted overall, and the economic outlook and the path of inflation remain conditional on continued support from monetary policy,” he told a news conference. “Therefore, an ample degree of monetary stimulus remains necessary.”
Designed nearly three years ago, the bond buys worth more than €2 trillion depressed borrowing costs and lifted growth but failed to raise inflation to the ECB’s target of almost 2%. That forced the bank to hedge its bets with what some investors described as “dovish policy tightening.”
The ECB will now cut its bond buys in half to €30 billion a month from January. Given robust growth, it kept the option to raise or extend buys and promised to reinvest maturing funds for years to come.
It also promised banks ample liquidity and said the bond buys would not end suddenly, suggesting that another extension, even if only to gradually wind down purchases, was likely.
“This is not tapering, it’s just a downsize,” Draghi said, using the market term for beginning to exit a stimulus program.
“The decision today is for an open-ended program... it’s not going to stop suddenly,” he added. “There is still a large amount of uncertainty.”
The cautious move may also have reflected policy makers’ concerns about the euro’s appreciation against the dollar this year and their aim to keep the currency stable after its surge over the summer.
The euro fell nearly 0.8% on the day even as Draghi omitted a now customary reference about the need to monitor the currency.
“Today’s decision is the first real baby step towards a very gentle exit from the ECB’s crisis mode. But it is definitely not a big-bang U-turn,” ING economist Carsten Brzeski said. “In fact, the... recalibration illustrates the ECB wants to start the exit as cautiously as possible, ideally without seeing the euro appreciate or bond yields increase.”
DILEMMA
The biggest debate appeared to be about whether to keep asset buys open-ended, with Draghi highlighting dissent from hawks, who wanted the ECB pave the way to the exit.
Still, Draghi said there was a large majority for an open-ended program, while other issues were supported by consensus or near consensus.
Hawks such as Germany and the Netherlands have argued that growth is now above trend, and more purchases do next to nothing for inflation, so keeping the program open-ended is not justified. Doves on the bloc’s periphery, however, warned that a quick exit could tighten financial conditions, undoing years of work.
“The fact that the ECB made the tapering decision look as dovish as possible because of the weak inflation causes a risk of a later move in rates than in our forecast,” Nordea economist Tuuli Koivu said.
“The possible first rate hike – even if only a cosmetic in nature – that we expect to see in the first quarter of 2019 may come later,” he added.
The ECB’s problem is that while it is dealing with a superb growth run, which justifies reduced stimulus, inflation is barely responding.
Draghi said data pointed to unabated growth as employment rises, households continue to spend and exports are on the upswing.
Yet, underlying inflation has not yet shown any convincing signs of an upward trend, and the outlook for both inflation and growth remained conditional on continued support from the ECB.
“If the outlook becomes less favorable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the Governing Council stands ready to increase the asset-purchase program in terms of size and/or duration,” Draghi said.
Interest rates were left unchanged as expected, and the ECB reaffirmed its guidance to keep them unchanged until well after its bond buys end.
The ECB is slowly running out of bonds to buy. But Draghi dismissed arguments that scarcity of available debt would constrain the program, as the ECB had plenty of flexibility.
Still, economists argue that the ECB will be nearing its limits by the end of its nine-month extension, particularly in Germany, the euro zone’s biggest economy, making another extension difficult without a major redesign of parameters.
“Our program is flexible enough that we can adjust its size,” Draghi said.