Author: Claire Jones
Posted on: Financial Times | October 18th, 2017
The European Central Bank looks set to remain active in the eurozone bond markets for most of 2018, confounding expectations that policymakers would end their landmark €60bn-a-month quantitative easing programme as early as June next year.
ECB watchers now expect Mario Draghi, its president, to say at the next governing council meeting on October 26 that the central bank will continue its asset purchases until next September — or possibly even December 2018. “It’s the first time since QE began that the communication from the eurozone’s monetary policymakers is clear: both the hawks and the doves seem in agreement that it will be a slow taper,” said Frederik Ducrozet, economist at Pictet Wealth Management. The trade-off is that, in exchange for staying in the market for longer, the eurozone’s central bankers will, from January, buy fewer bonds each month. The figure could fall from the current level of €60bn to as low as €20bn, should the ECB’s governing council extend QE until December 2018. Up until recent weeks most analysts had expected the council to buy €40bn-worth of bonds a month, but only for the opening six months of the year.
Investors care more about the total amount of assets the ECB buys than the speed of its purchases. So what are the advantages of buying fewer bonds each month but remaining active in markets for longer?
Stronger rate guidance
The prime motive for a slower taper is that it would push back expectations of an interest rate rise in the eurozone into 2019. That, in turn, should remove one of the big stumbling blocks to an exit from QE — the strength of the single currency. The bank’s main refinancing rate is now zero, while its deposit rate is at minus 0.4 per cent — in effect a charge on banks for holding cash. The ECB council had promised to keep rates at record lows “well past the horizon” of QE to cement the region’s economic recovery.
By 2019, the US Federal Reserve’s main interest rates are expected to rise from the current level of between 1 and 1.25 per cent to about 2 per cent. The widening of the gap between eurozone and US interest rates should keep a lid on the single currency and increase the chances of the ECB hitting its inflation target of just under 2 per cent. “The main reason for doing it is to strengthen the forward guidance. That’s what is on the council’s mind the most,” said Carsten Brzeski, economist at ING-DiBa, a bank.
A chronic problem with eurozone QE is that markets have long suspected that the ECB could run out of assets to buy given that the legal limits on what government bonds it can purchase are much stricter than for other central banks. The design of the programme means bonds are bought according to each national central bank’s capital share at the ECB — in effect mirroring the size of member states’ economies, the biggest being Germany’s. The issue is that there is not that much eligible German debt to buy.
Those limitations become looser the longer the programme goes on for and the slower the pace of purchases, with more debt becoming available to buy over time as German authorities issue more debt. Share this graphic Officials think there are about €300bn worth of eurozone bonds left that they could buy. They would prefer to commit to purchases of slightly less than €300bn to have some room to speed up should conditions deteriorate. “You have to give yourself some room; the larger the reduction, the greater the credibility,” MrDucrozet said.
Another appeal of a slower taper is that it is a suitable compromise for policymakers and European investors. It would give markets more time to prepare for the day when the ECB is no longer adding to its stock of government bonds, while also committing policymakers to keep rates low for a long period of time. Policymakers are increasingly confident markets can cope with less support. “Economics is not quantum physics — we don’t know exactly how markets will react,” said one member of the council. “We’ll try to minimise as much as possible the impact on markets, but we don’t need to act in a way that will inflict a lot of damage.” And while hawkish members such as Germany’s Bundesbank would prefer an earlier exit, they also know that a cut in purchases from €40bn in June to zero in July is unlikely to happen. A decision to commit to a longer taper could prove the cheaper option. Any objections are likely to remain in-house and will not spill over into the public domain