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Economy : ECB to Scale Down but Extend Bond-Buying Program

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10/26/2017 | 06:52pm CET
By Tom Fairless 

FRANKFURT -- European Central Bank unveiled plans on Thursday to scale down its giant bond-buying program while extending it deep into 2018, a gentle policy shift that kept financial markets calm but failed to win the support of Germany's Bundesbank, which wanted a faster change of course.

The keenly awaited decision threads a path between the ECB's growing confidence that the eurozone's economic recovery can proceed with less support from the central bank, and concerns that inflation -- the ECB's primary focus -- remains too weak.

Under the plans, the ECB will continue to buy bonds through September 2018, but cut the pace of its purchases to EUR30 billion ($35.4 billion) a month from EUR60 billion after December this year. The bank also left its key interest rates unchanged.

The ECB's move sets it on the same path toward higher interest rates as the Federal Reserve, albeit four years later, amid a broad economic upswing that is spreading to all parts of Europe's currency union.

The decision drew dissent on the ECB's 25-member rate-setting committee. Bundesbank President Jens Weidmann opposed it, worried that the ECB hadn't yet drawn the curtain on quantitative easing -- as the bond-buying program is known -- despite the eurozone's robust economic recovery, according to a person familiar with his thinking. Mr. Weidmann is a longtime critic of the ECB's bond purchases, and has been arguing for a quicker withdrawal of monetary stimulus.

Mr. Weidmann would have been willing to support a fresh extension of quantitative easing if the program's end had been more clearly in sight, the person said. Some other members also had reservations about keeping QE open-ended, ECB officials said.

At a news conference, Mr. Draghi stressed that the move wouldn't mean the end of the ECB's bond purchases, which economists credit with bolstering the region's strong economic recovery. Indeed, the ECB chief indicated QE would be extended again, beyond September 2018, an unexpected sweetener for investors.

"This is not tapering, it's a downsize," Mr. Draghi said. The word "tapering," shorthand for winding QE down to zero, wasn't mentioned in the ECB's policy discussions, he said.

Investors welcomed Mr. Draghi's balancing act, which pushed back market expectations for an ECB interest-rate increase deep into 2019.

"This is softly, softly tapering," said Ian Stewart, chief economist at Deloitte. "The ECB certainly isn't taking away the punchbowl."

The euro fell 1% against the dollar on Thursday, on track for its biggest daily decline since August, while shares of companies in the eurozone's most indebted nations jumped on a bet that the ECB's extraordinary monetary stimulus would support the region's markets for longer than many had anticipated.

While the decision to extend QE was widely expected, the ECB threw in some additional sweeteners, including a promise to reinvest the proceeds of maturing bonds for "an extended period of time," and to lend freely to banks against collateral at least until the end of 2019. Mr. Draghi underlined the importance of the commitment to reinvest, and while declining to give an estimate of the amounts involved, said they were "going to be massive."

For some investors, the ECB's caution highlighted a growing gulf with the Fed, which is expected to raise interest rates in December for the third time this year. That policy gap has weighed on the euro and widened a divergence between German and U.S. government bonds this fall.

Mr. Draghi spoke glowingly of the eurozone's economic recovery, but argued it was heavily reliant on "ample" support from the central bank. "We must be patient and persistent," he said.

The commitment to keep the QE program open-ended gives the ECB flexibility to respond to future economic turbulence, ahead of national elections in Italy and a possible change of leadership at the Federal Reserve.

It is the third time that the ECB has extended its calendar for QE. The latest move will push the overall size of the program above EUR2.5 trillion, or almost a quarter of the region's economic output, and more than double its originally planned size.

But it leaves little room for error. By September, the ECB will have almost exhausted the bonds that it is allowed to purchase under the current rules of QE, which limit the bank from buying only 33% of any individual government's debt. That raises questions about the ECB's ability to respond to any future crisis -- despite the bank's stated willingness to scale up the program again if necessary.

Mr. Draghi declined to address concerns about possible bond shortages on Thursday. He said policy makers hadn't discussed any change to the self-imposed rules governing QE, but insisted they would be able to find enough bonds if needed.

Some ECB officials doubt the credibility of that pledge, including Mr. Weidmann, according to a person familiar with the matter.

Despite the ECB's caution, investors worry that higher borrowing costs could put pressure on the region's highly indebted households, private firms and governments, many of which have made little progress in paying down the debts accumulated during the recent financial crisis.

On the other hand, the extension of QE is likely to deepen concerns, particularly in Germany, about the harmful side effects of years of easy money. They include potential asset-price bubbles, lower returns for savers, and the misallocation of resources to nonviable "zombie" firms. Critics contend that such adverse side effects accumulate over time, even as the positive impact of QE diminishes.

--Riva Gold and Paul Hannon in London contributed to this article.

Write to Tom Fairless at [email protected]

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