High noon for the European Central Bank, Draghi at the QE Corral

FRANKFURT — Not for the first time, European Central Bank (ECB) President Mario Draghi is facing a tricky balancing act.

With the euro zone economic recovery well into its fifth year, the time has come to cut stimulus.

Yet, overly ambitious tightening could choke off the very growth Mr. Draghi has fostered, threatening to undo years of work.

Mr. Draghi also has to find common ground between policy hawks, who argue the ECB has spent its firepower so any further stimulus has negligible effect, and doves, who point to persistently weak inflation as evidence the bank has not met its price-stability mandate.

The compromise is likely to be a cut in bond purchases at Thursday’s policy meeting, twinned with a lengthy extension of stimulus and a commitment to keep rates low for many years to come.

Such a move would ensure that easy policy persists while also reducing the ECB’s reliance on unconventional tools and potentially paving the way to exit bond purchases.

The problem is that while growth is on its best run in a decade, unemployment remains high, wage growth is barely visible and inflation will probably not rise back to the ECB’s target before the end of the decade.

The bond purchases have depressed borrowing costs but the ECB is slowly running out of debt to buy so it either takes a step towards the exit or redraws the rules of the program, a potentially controversial move that may send the wrong signal.

A Reuters poll of economists concluded the ECB it will start trimming its monthly asset purchases to €40 billion from €60 billion in January.

It was mostly split on whether the program would last six or nine more months after that.

Sources close to the ECB’s pre-meeting discussions say the a nine- month extension seems likely with debate over monthly volumes between €25 billion and €40 billion a month.

But the real issue will be whether to keep the asset buys open ended, making another extension possible, or signal an eventual end of bond purchases, as demanded by hawks, including powerhouse Germany.

While this debate is still open, sources speaking to Reuters said it is more likely the bank would maintain the flexibility and even signal a willingness to increase asset buys if the outlook sours.

That, says UBS, is crucial: “We view the duration of the extension in net asset purchases as more important than the monthly size in ensuring the ECB’s ability to manage the expectations around its future policy.”

New bond purchases will add little to inflation.

But they will buy the ECB some time as it waits for growth to finally translate into inflation.

In a glimmer of hope for policy makers, Germany’s largest trade union recently asked for a six percent wage hike for nearly 4 million workers, an ambitious move, which could lift wages across the board as many employee groups look to IG Metall to set the trend.

Euro zone inflation — currently at 1.5% — remains well below the ECB’s target of almost two percent and expectations are for it to stay that way at least until 2019.

While the euro zone enjoys its growth run, the United States, the world’s biggest economy, probably suffered a major hit last quarter, mostly due to the disruptions from hurricanes. —