Policy Watershed

The art of imprecision

This tap can trickle for a good long time. Source: Shutterstock

There’s one word that Mario Draghi studiously avoids: “tapering,” which is economists’ speak for a phase-out of the European Central Bank’s bond purchases. Perhaps the term sounds too predicable for Mr. Draghi, who likes to keep the markets guessing on the timing of major policy decisions. Instead, the ECB’s boss prefers a vaguer “readjusting” whenever he talks about the inevitable.

There’s a good reason for these linguistic nuances. Mr. Draghi wants to avoid an abrupt end to the ECB’s current monetary policy, its most expansionary for decades. Every month, as part of its so-called quantitative easing, the ECB buys €60 billion ($70 billion) in euro-zone member government and corporate bonds in a bid to stoke inflation, which has been stubbornly low. However, the program is scheduled to expire at the end of 2017, so the ECB will soon have to act. Hence its discussions later this month about orchestrating an exit.

According to ECB sources, Mr. Draghi wants to keep his options open on the scheme’s timetable, without appearing indecisive. Most members of the ECB’s governing council seem to support this strategy, and the minutes of its September meeting on interest rates, which were published on Thursday, suggest the need for wiggle room.

“The meeting was obviously the final step before the first details are announced,” said Carsten Brzeski, chief economist at ING-DiBa bank in Frankfurt. The minutes indicate that the ECB’s council went over various scenarios for tweaking its purchases, which are said to involve “weighing up the volume and duration” of the bond-buying program.

06 Euro-Zone Inflation-01

Unlike in the United States, where the Federal Reserve has gradually scaled back its bond purchases, Mr. Draghi and his colleagues on the ECB council balk at committing themselves to a phase-out period. Jens Weidmann, president of the Bundesbank (Germany’s national central bank) and his Dutch counterpart Klaas Knot have expressed support for a clear cut-off, but they are in a minority. “I assume that we will transition to a cautious deceleration at the start of the coming year,” said Ewald Nowotny, a member of the ECB’s governing council.

The most convincing argument for further bond purchases, as put forward by Mr. Draghi and his allies, is that inflation remains tepid. In September, euro-zone consumer prices rose 1.5 percent (see chart above), below the ECB’s target of about 2 percent.

ECB policy-makers have voiced concerns that the Euro could strengthen further if the program ends too quickly. A strong Euro tends to curb exports, as Euro-denominated goods become more expensive in other currencies. “The current fluctuations in the euro exchange rate are a source of uncertainty,” the minutes warned. Under a flexible approach, the ECB could buy fewer bonds from January onwards, but leave the next steps open.

Another problem the ECB is struggling with: There are legal limits to its bond-purchase program. The central bank may hold no more than 33 percent of outstanding bonds of any EU member, and is bumping up against this threshold in some countries. This might suggest the central bank has exhausted its arsenal of policy tools, some ECB sources fear. And that, in turn, could spark unwanted turbulence on financial markets.

The ECB is increasingly coming up against legal limits in its bond-purchase program.

“If the ECB demonstrates its other instruments it can use to respond to an emergency, it could curb swings in interest rates and the exchange rate,” said Michael Schubert, an economist at Commerzbank. The minutes hint the central bank may fine-tune its approach, perhaps by reinvesting bonds due to mature, or making long-term loans to banks.

Peter Praet, the ECB’s chief economist, has pointed out that the stimulus provided by the bond purchases also depends on the maturities, or lifespans, of the bonds the central bank buys. That means, even if the ECB’s bond holdings remain constant in Euros, the effect of these purchases on the economy will vary. As a result, the ECB tries to replace maturing bonds with similar ones.

Many traders expect the purchases will be extended by six months from January 2018, and to drop purchases to a monthly €40 billion. Another scenario might see a drop to €20 billion with a longer extension, of perhaps nine to 12 months.

The allure of a longer timetable? An interest-rate hike in 2018 may already be priced into the markets. “If the ECB decides on a longer period of nine or twelve months for its bond purchases, it would postpone expectations of an interest-rate rise,” said Mr. Schubert. This would help the central bank keep its powder dry, at a time when it’s in short supply.

Jan Mallien covers monetary policy for Handelsblatt from Frankfurt. Jeremy Gray adapted this story for Handelsblatt Global. To contact the author: mallien@handelsblatt.com

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