ECB QE Is Dead. Long Live ECB Stimulus
The end of bond purchases is nigh, but officials need to find a way to maintain support for troubled countries.
The hawks at the European Central Bank are making their presence felt. They want the policy meeting in Latvia on June 14 to be a "live" meeting for deciding on the end of quantitative easing, rather than yet another showcase for stalling and delay. And it looks likely they’ll get their way – Chief Economist Peter Praet said in a speech in Berlin on Wednesday that policy makers will have to assess the matter.
This development has been a long time coming, and it’s a mark of how much the European economy has improved. But this does not mean ECB stimulus will, or should, stop. A renewed selloff in shorter-dated Italian bonds shows the central bank must tread very carefully.
The time is right to decide on ending QE – this is just the first stage in a process of eventually returning to positive interest rates. The current 30 billion euro ($35 billion) monthly buying program expires in September, and the strength of the economy makes it extremely difficult for policy makers to backpedal on the tapering that they've already signaled. What’s up for grabs is the timing and amount of the tapering.
It helps the case of the hawks that the euro is five percent lower since mid-April. Its gains versus the dollar earlier in the year had sparked concern on the Governing Council that a stronger common currency could jeopardize its efforts to revive growth and breathe inflation back into the euro area. The bank’s new quarterly forecasts should show that inflation is on track to hit the target of below but close to two percent. It’s nearly impossible to see how nations such as Germany and France need any more help from bond purchases.
But these are far from the only issues policy makers need to consider. Italy’s political upheaval and market panic surely presents a whole new level of risk in stopping QE. And Greece is due to exit its fourth bailout program in August – there’s no guarantee that the process will be smooth.
For troubled countries, the ECB’s presence as a consistent buyer in their government bond markets has given them political breathing space by keeping yields low. It’s tough to see how the bank can suddenly withdraw its presence for these nations without serious consequences. Though its commitment to reinvesting maturing securities will maintain stocks of purchases, the end of the monthly buying flow could be a huge problem.
It would be a step too far for the hawks to sanction an extension of bond purchases into 2019. But ending the stimulus too soon could see the ECB's hard-fought progress unravel. It calls for a classic compromise by President Mario Draghi to buy some more time. Officials will need to present alternative measures to QE that can provide the back stop that the weaker European economies still evidently need.
Draghi could present the framework for ending bond purchases next week, and also signal that a clear decision on stopping will be made at the next policy meeting, on July 26. By that time, the June 21 Eurogroup meeting should have revealed the terms of Greece’s exit, and Italy's new government will have had time to bed down. And that’s probably as close as we’ll get to feeling comfortable that European politics are stable enough to cope with the end of of QE.
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