It’s not the first time Mario Draghi will have felt misunderstood. On Tuesday, a speech he gave at the European Central Bank’s annual forum in Sintra, Portugal, sent the euro surging upwards. Markets believed he was signaling an earlier end to the ECB’s loose monetary policy. A day later, Mr. Draghi’s ECB let it be known that markets had gone too far: His statement was supposed to be more measured. The euro tumbled, though it was spiking again by week’s end.
The episode shows that communication is key as the Frankfurt-based central bank slowly thinks about how to wind down the extraordinary steps it has taken since the 2008 financial crisis to keep the euro zone’s economy from collapsing. Just ask the U.S. Federal Reserve, which is widely seen as having messed up its own exit a year ago.
But communication isn’t everything. The reality is the ECB can’t keep up its loose monetary policy, which has included buying nearly €2 trillion in corporate and government bonds, much longer. Whether Mr. Draghi likes it or not, there simply aren’t enough bonds left to buy – especially in Germany.
This isn’t just about Germany’s well-known opposition to the ECB’s policies. The trouble is that the ECB has a legal limit to how much it can buy.
The problem won’t come to a head until next year. For now, the ECB is still buying about €60 billion in bonds each month and has promised to do so through the end of 2017. Interest rates have also been kept at a record low of 0 percent, while a separate “deposit” rate that is charged to banks that park their excess reserves with the ECB has been held in negative territory at -0.4 percent.
All of this has been designed to revive a struggling euro-zone economy and push up inflation, which central banks like to keep near an annual rate of 2 percent. The 19-country currency bloc’s inflation rate was just 1.4 percent in May, though the ECB and most economists expect prices to pick up again in the second half of the year.
What happens in 2018 is where it gets messy. Economists are divided on how much longer the ECB should keep its massive bond-buying program going – in other words, they disagree on how much of a stimulus the euro zone’s economy still needs – though most expect the central bank to at least start winding down its program in the first half of the year.
Mario Draghi has been rather coy about the pace of that slowdown, also known as “tapering,” which is why his comments on Tuesday left room for interpretation. Most economists expect the ECB will provide some clarity by September at the latest. Until then, markets could swing on any little announcement that pushes the needle one way or the other – just like they did this week.
To be sure, many German economists, central bankers and banking executives have long been arguing that the European Central Bank’s monetary policy is too loose, that it should dial back on its massive stimulus sooner rather than later before it causes financial markets to overheat and banks, which are struggling to earn a living in this age of low interest rates, to go bust.
But this isn’t just about Germany’s well-known opposition to the ECB’s policies. The trouble is that the ECB has a legal limit to how much it can buy. The ECB may be able to print money when it likes, but when it comes to buying government bonds on the open market, there’s a finite amount available. In other words, the decision about when to cut back may not really be up to Mr. Draghi at all.
The ECB has some very specific rules on how much it can buy. Not only must it spread its bond purchases evenly across the 19 euro-zone countries to avoid bias, it also has specific rules on how many bonds it can buy in each country (not more than 33 percent of outstanding bonds) to avoid distorting the private marketplace.
This is where Germany comes in. As Europe’s largest economy, the ECB has to buy more bonds here than anywhere else – about a quarter of its total purchases according to the central bank’s ”capital key” that dictates how much to buy from each country. That’s created a certain irony – Germany’s economy is in need of the least help, but has actually seen interest rates fall the furthest.
Now, the ECB is fast hitting its upper limit in Germany.
“Even a lax interpretation of the capital key can’t cancel out the emissions limits. The ECB therefore has to taper in 2018, in other words slowly wind down its bond purchases,” said Michael Leister, an analyst at Commerzbank.
True, the ECB can tweak its buying practices – it can buy bonds of longer maturities, for example – but the central bank has already used up much of that wiggle-room. In Germany, it is already buying bonds with a maturity of up to 30 years. So its options are limited.
There’s another problem specific to Germany: While there’s tremendous interest among investors in buying German bonds, which are seen as safer than other countries, Berlin is currently balancing its budget. That’s limiting the amount of new debt coming to market.
There is what might be called a nuclear option: The ECB could abandon its 33-percent limit and invest more heavily in German debt. Or it could abandon its agnostic approach and buy more bonds from, say, Italy or Spain. Some economists have called for the latter.
“The ECB does not need to buy more German bonds,” said Fabian Lindner, an analyst with the union-linked Macroeconomic Policy Institute, IMK. “I would say other kinds of assets should be bought.”
That’s unlikely to happen, however. Even ECB board members have said they’re unwilling to bend the rules that much. Such a move would be almost certain to bring a legal challenge. And unlike previous legal cases, this is one the ECB would probably lose.
Christopher Cermak is an editor with Handelsblatt Global in Berlin. Andrea Cünnen covers financial markets and Jan Mallien covers the European Central Bank for Handelsblatt from Frankfurt. To contact the authors: Cermak@handelsblatt.com, firstname.lastname@example.org, and Mallien@handelsblatt.com