ECB Uncertainty

When Will the Bond Phase-Out Begin?

Germany European Central Bank
Mario Draghi has some explaining to do. Photo: AP
  • Why it matters

    Why it matters

    The uncertainty is harming markets, though investors are also worried that the ECB pulling the plug too soon could send stocks on a nose dive.

  • Facts

    Facts

    • The ECB is trying to avoid a panic like the one that occurred in 2013, when the Fed announced the phase-out of its bond-buying program and sent stocks into a tailspin.
    • Inflation in the 19-nation euro zone rose by the largest amount in two years in September.
    • The ECB is currently spending €80 billion a month in corporate and government bonds of euro zone countries.
  • Audio

    Audio

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A bogeyman is back, and it responds to the seemingly unremarkable name “tapering.”

It was the word the U.S. central bank, the Federal Reserve, used to refer to the phase-out of its bond-buying program a few years ago.

When then Fed Chairman Ben Bernanke announced, in May 2013, that the Fed was going to allow its bond purchases to expire, it triggered a medium-sized earthquake in the markets.

Now the markets – this time in Europe – are fearful of tapering once again.

When Mario Draghi appears before the press after the latest meeting of the governing council of the European Central Bank on Thursday, he will have some questions to answer.

The groundwork for his critical press conference was set earlier this month: Markets shuddered in response to a report by news agency Bloomberg that the ECB was considering a reduction in its bond purchases. Some traders felt reminded of 2013, but the Frankfurt-based ECB is determined to avoid the kind of panic that occurred back then in the United States.

Fears are probably premature, as most economists assume that the central bank will not make any far-reaching poliicy decisions this week.

The ECB’s currently buys about €80 billion a month in corporate and government bonds of euro zone countries in a bid to jumpstart the bloc’s economy by holding down interest rates. The ECB has said that it will continue buying bonds at this rate at least until March of next year.

So the ECB has time to make its next move. The central bank will probably wait until December to decide on extending the bond purchases and possibly changing its purchasing modalities, according to Sylvain Broyer, chief economist with French investment bank Natixis in Germany.

The rumors have also had the positive side effect of leading to rising interest rates in the bond market. This is somewhat helpful to ailing banks in the euro area, which benefit from rising interest rates.

“It will be interesting to see what position Mario Draghi takes with regard to the tapering rumors,” he said. Mr. Broyer assumes that the ECB head will exercise restraint. “It is too early for the ECB to begin officially talking about tapering,” he added, noting that the central bank is likely to wait and see whether inflation continues to rise.

Consumer prices in the currency bloc are indeed starting to creep up, though they remain well below the ECB’s official mandate of keeping inflation “close to but below” 2 percent.

In September, prices in the euro area rose by 0.4 percent in comparison to the previous year, the largest increase in about two years. This development is likely to continue in the coming months, primarily because of the so-called base effect of the price of oil. The oil price fell to below $30 (€27) a barrel at the beginning of the year, but oil is now trading at above $50 a barrel. Because the oil price was so low at the beginning of 2016, prices were able to increase more substantially relative to it.

Given the oil price effect, Mr. Broyer expects inflation to rise to about 1.7 percent by March 2017. That would be in line with the ECB’s goal.

Nevertheless, he anticipates that the ECB in December will extend its bond-buying program at the current level by another six months. “If nothing happens in the meantime, it will be able to announce tapering between spring and September,” Mr. Boyer said.

That doesn’t mean the planning shouldn’t start now, and it’s possible Mr. Draghi will give some hints to that effect during his press conference. To avoid a panic like the one that occurred in the United States in 2013, now is the right time to cautiously prepare markets for the phase-out.

“Rumors about a possible phase-out of the bond purchases come at the right time for the ECB,” he said, because they enable it to gauge the reaction in markets.

Paradoxically, the rumors may have also had the positive side effect of leading to rising interest rates in bond markets. While the ECB has been trying to keep interest rates low, its policies have also been hurting financial firms on the Continent. Rising bond prices are therefore somewhat helpful to ailing banks in the euro area, which benefit from rising interest rates.

It also defuses the problem that the pool of bonds available for the ECB to purchase is getting smaller and smaller. Under its own rules, the central bank is not permitted to buy bonds with rates lower than the deposit rate it charges banks that park reserves with the central bank. That deposit rate is currently negative at 0.4 percent. But rates on many government bonds have already fallen below even this level.

This is why Mr. Draghi and his colleagues asked the central bank’s experts in September to examine options for a smooth transformation of the program. It is conceivable that the ECB will soon begin buying bonds with yields below the deposit rate.

Because technical changes to the program depend heavily on whether or not it is extended, there is reason to believe that the ECB will tie together the two decisions. Still, it’s probably too early for that this week.

In December, the ECB will release new economic growth and inflation forecasts through 2019. At that point it will presumably extend its purchases. However, investors should be aware that it could be the last time.

 

Jan Mallien covers monetary policy for Handelsblatt out of Frankfurt. To contact the author: mallien@handelsblatt.com

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