Markets

Mark Gilbert is a Bloomberg Gadfly columnist covering asset management. He previously was a Bloomberg View columnist, and prior to that the London bureau chief for Bloomberg News. He is the author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”

On Thursday, the European Central Bank has promised to reveal how its quantitative easing program will be recalibrated -- President Mario Draghi's preferred term for what everyone else calls tapering. After arriving late to the QE party, the ECB has done more than its peers to pump up the volume of its balance sheet.

Leader of the Pack
Central bank balance sheets in dollars
Source: Bloomberg

Whatever modification is introduced, the ECB's balance sheet will reach as close to 5 trillion euros ($5.9 trillion) next year as makes no difference, whether the monthly bond purchases are cut to 40 billion euros or 30 billion euros, for six months or nine months or 12 months.

Final Destination
The ECB's balance sheet will reach almost 5 trillion euros no matter which estimate of the pace of QE slowing is correct
Source: Bloomberg calculations

While the flow of QE will be reduced as the monthly pace of bond-buying is curtailed, the stock of debt held under the Public Sector Purchase Program will continue to grow. And the latter, according to a May research paper by ECB economists Roberto A. De Santis and Fédéric Holm-Hadulla, matters more for bond yields:

Flow effects accounted for only a limited share of the overall impact of PSPP on sovereign yields in the euro area. Instead, most of the downward pressure of PSPP on sovereign bond yields seems to have derived from "stock effects," which materialized in anticipation and upon announcement of key program parameters.

Settle Down, Now
10-year yields in the euro zone have compressed
Source: Bloomberg

Euro zone officials are mindful of the so-called taper tantrum that accompanied the Federal Reserve's first hints at easing back on stimulus in June 2013. Even the suggestion that bond-buying might be moderated was enough to drive the 10-year Treasury yield up by 40 basis points in a week to 2.6 percent, climbing to 3 percent within less than three months.

The ECB has been careful to warn traders and investors of its intentions well in advance. So the bond market is unlikely to take fright. What might push up borrowing costs, though, is the underlying strength of the euro zone economy (which is, after all, the reason for the ECB tweaking QE in the first place).

The pace of economic improvement has prompted traders to revise their expectations for how quickly the official deposit rate might be raised from its current minus 0.4 percent level.

Shifting Sentiment
How market expectations for the ECB interest rate have changed this year
Source: Bloomberg's MIPR function

Draghi is likely to watch his words carefully on Thursday. He'll likely stress that the central bank is taking its foot off the monetary accelerator rather than tapping on the policy brakes. If the euro-zone economy continues to accelerate at its current escape velocity, though, those rate-rise expectations might be brought even further forward.

The ECB is adamant that rates won’t rise until the QE program is over. But if -- and it's admittedly a big if -- a better growth outlook starts to incite inflation, an end to the bond-purchase program might start to look more likely before the middle of next year. The combination of a full QE halt, higher rates and a resurging economy might be enough to propel bond yields higher.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Mark Gilbert in London at magilbert@bloomberg.net

To contact the editor responsible for this story:
Jennifer Ryan at jryan13@bloomberg.net