ECB Bonds

Whatever You Do, Don't Say Taper

Draghi, President of the ECB and Weidmann, President of German Bundesbank shake hands with students during the Generation Euro Students’ Award ceremony in Frankfurt
For once, Mario Draghi and Jens Weidmann might actually see eye to eye. Source: Reuters

“Taper…tantrum,” is how that psychological word association test would probably go with investors. The exercise would raise ugly memories of when the US Federal Reserve first surprised financial markets back in 2013 by suggesting the end was near for its massive injections of cash into the US economy, known as quantitative easing. Markets tumbled.

Such a tantrum is exactly what the European Central Bank is trying to avoid as it enters a crucial meeting this week. The Frankfurt-based central bank’s governing council will announce on Thursday what it plans to do with its own loose monetary policy, which has been propping up the euro zone’s lackluster economy for nearly three years now.

The best way to stop a tantrum? Don’t talk of a taper. In that vein, the ECB seems increasingly unlikely to actually announce an end-date for the trillion-euro bond buying program that has been at the center of its efforts to boost the continent’s economy. Even the German central bank, long a critic of the ECB’s policies, seems unwilling to risk a tantrum now.

“The clearer it is that the purchases will wind down, the more likely Jens Weidmann will vote in favor.”

Bundesbank insider

The ECB’s bond-buying program, which has seen the central bank purchase more than €2 trillion in government and corporate debt since March 2015, is set to end in December, unless the ECB announces its extension. That now seems likely to happen on Thursday: Most analysts expect the central bank to keep the program going for another nine months, or even a year, albeit at about half its current level.

The ECB currently buys about €60 billion in bonds per month. Central bankers of nearly all European stripes agree that number should be cut starting in January. As late as a month ago, the general consensus was that the program would be cut to around €40 billion in January, with further cuts perhaps three or six months later. Some had expected the program to come to a complete stop as early as end-June. It is this process of reducing the purchases to nothing that is known as “tapering” in financial lingo. That consensus has changed in the last two to three weeks, according to ING-Diba chief economist Carsten Brzeski, based on the latest comments from central bankers.

Among them is Peter Praet, the ECB’s chief economist, who has said repeatedly in recent weeks that there were good arguments for keeping the bond-buying program running longer at a lower level. For one thing, it would actually calm financial market nerves about the next step, raising interest rates, since the ECB has already made clear it will only start raising rates once its bond-buying program has come to an end. A “lower for longer” approach would also allow the ECB to delay the point at which it reaches the limits of its program and can’t buy any more bonds. This is especially true in Germany.

It’s a plan that even the more hawkish central bankers in northern Europe, led by Germany, may be willing to get behind. While Bundesbank President Jens Weidmann is a well-documented opponent of the ECB’s easy-money policies, he’s also worried about what a quick exit will do to financial markets that in his view have grown dangerously dependent on the ECB’s cash. Sources say he may be willing to vote in favor of a step-by-step approach as a result. That echoes remarks from Ardo Hansson, head of the Estonian central bank, who last week told Handelsblatt that while a specific end-date for the program matters little, key is that there is a “clear path” towards reducing the purchases.

It marks a rare point of agreement between Mr. Weidmann and ECB President Mario Draghi, who has studiously avoided using the word “tapering.” Instead he’s spoken in terms of adjustments, which is why Mr. Brzeski finds it unlikely the central bank will announce a final date for the program. Avoiding the term also gives the ECB greater flexibility. The euro zone’s economy is currently on the rebound – the OECD believes Europe could grow at a faster rate than the United States this year – but if the economy tanks unexpectedly, a flexible approach would allow the central bank to ramp up spending again.

Mr. Weidmann isn’t necessarily a fan of that flexibility – he would no doubt hate to see the bond purchases stepped up again at a later date – yet insiders say Mr. Weidmann isn’t going to demand a final end-date to the program in exchange for his support. But he does want a signal: “The clearer it is that the purchases will wind down, the more likely he will vote in favor,” said one insider familiar with the Bundesbank’s discussions.

In other words, taper quietly. And make sure not to provoke a tantrum.

Christopher Cermak is an editor with Handelsblatt Global, currently based in Washington DC. Jan Mallien covers monetary policy for Handelsblatt in Frankfurt. To contact the authors: cermak@handelsblatt.com and mallien@handelsblatt.com

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