ECB Haunted by Ghost of Christmas Past as Stimulus Choice Nears

  • Economists see QE extended by about six months at current pace
  • Anything less may repeat last December’s market sell-off

Markets Count on Draghi to Extend ECB's QE Program

If Mario Draghi wants to avoid a repeat of the market carnage his press conference sparked a year ago, he might have to negotiate a few roadblocks.

QuickTake Europe’s QE Quandary

Almost all economists surveyed by Bloomberg expect the European Central Bank president to announce on Thursday that the institution’s bond-buying program will be extended after March, and most foresee an extension of about six months at the current 80 billion euros ($85 billion) a month. Anything less could bring echoes of Dec. 3, 2015, when Draghi capped weeks of buildup with underwhelming stimulus that sent bond yields and the euro surging.

This time, with bond scarcity bolstering the case of hawks who want the ECB to tread cautiously, his still-dovish tone has been slightly tempered. While the outlook for rising inflation is heavily reliant on continued monetary accommodation, the amount of monthly bond purchases and the program’s duration can be flexibly arranged, he said in a rare interview last week. 

“Monetary policy communication is clearly much more difficult than it used to be,” said Mark Dowding, London-based partner and money manager at BlueBay Asset Management. “In the midst of this complicated menu of different items, the scope for the ECB to be trying to say one thing but the market to hear something different is clearly a risk that is present.”

Implementation

The ECB has already spent 1.4 trillion euros on quantitative easing, a figure that will rise to 1.7 trillion euros by the end of March. A crucial hurdle to enlarging it even further is that some assets simply aren’t eligible to buy under self-imposed rules.

Economists in the Bloomberg survey predict that the Governing Council will probably opt to raise the maximum share of any single public-sector security, or exposure to its issuers, that euro-area central banks can hold. Another option would be to scrap the requirement that yields should be above the deposit rate, currently minus 0.4 percent. Giving policy makers more leeway in allowing purchases to be linked to the amount of outstanding debt, rather than according to the size of each country’s economy, might also help.

While those solutions have been discussed publicly in previous weeks, they risk being seen as either tinkering around the edges or violating European Union law that bans monetary financing.

Justification

Convincing the Governing Council that some or all of those tweaks to QE rules may be needed, might be complicated. Some members advocate delaying the decision until next month, people familiar with the matter said in late November.

Negotiating a broad-based agreement that significantly more stimulus is warranted could be even more difficult, particularly if the chief risks are seen as political.

The U.K.’s vote to leave the EU, Donald Trump’s victory in the U.S. presidential election, Italy’s rejection of constitutional reform in a referendum that brought down the prime minister, and looming elections in the Netherlands, Germany and France have all been cited as reason to fret about the economic outlook.

“The idea that central banks can fight the sources of financial and sovereign-debt crises, globalization fears or increasing populism with cheap money is dangerous,” Bundesbank President Jens Weidmann said in a speech on Monday. “If the central bank continuously steps into the breach of politics or even tries to influence democratic processes, that would result in a politicization endangering its independence.”

One compromise could be to extend QE but cut the pace of monthly purchases. Draghi hinted at the option in an interview with Spanish newspaper El Pais, when he said the ECB can provide appropriate support “by different combinations of instruments, for instance the amount of monthly purchases or the length of time over which they take place.”

Given the level of anticipation, that may be a hard message to get across.

“There are always risks with these meetings that things don’t go as expected,” said Joerg Kraemer, chief economist at Commerzbank in Frankfurt. “Setting a lower purchase volume could give the impression of the beginning of the end. Amid so much market volatility and the aftermath of the Italian referendum, I doubt the ECB would want to send that kind of signal.”

Communication

Kraemer’s comments reflect another risk -- that by repeatedly saying the euro-area recovery is reliant on continued monetary stimulus, Draghi and his closest colleagues have already raised expectations too high.

It wouldn’t be the first time. Prior to the December 2015 meeting, Draghi said in a speech that officials would “do what we must to raise inflation as quickly as possible,” just as ECB chief economist Peter Praet warned that the institution’s credibility would be damaged if its policies didn’t start showing effects.

Investors read into that a larger scale of easing than was actually delivered, sending the euro up by the most in six years, and highlighting the difficulty in calibrating guidance to market participants who hang on the ECB chief’s every word.

Updated economic forecasts to be published on Thursday, including a first outlook for 2019, may suggest less stimulus is sufficient to carry the region through its fragile recovery and return inflation to just under 2 percent. Economic growth was driven by household and government consumption in the third quarter, Eurostat said Tuesday, confirming a previously reported 0.3 percent rate of expansion.

“We have quite good economic data and the ECB should spin on it -- they should sell it as what they have done had an impact,” said Anatoli Annenkov, senior economist at Societe Generale SA in London. “There is plenty of risk for a communication mistake.”

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