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Many observers expect the European Central Bank on Thursday to announce, or at least hint strongly, that the end is nigh for its massive support for the eurozone economy, although looming threats to the bloc will weigh on governors’ minds.
Central bankers’ monthly bond purchases of 30 billion euros ($35 billion) and ultra-low interest rates are designed to stoke growth in the 19-nation single currency area and power inflation to their target of just below 2.0 percent.
Growth has picked up across the bloc, although at a slower pace in early 2018 than last year – 0.4 percent between January and March compared with 0.7 percent in the previous three months.
Meanwhile, eurozone price growth surged to 1.9 percent in May, in line with the ECB’s target.
‘Core’ inflation discounting the most volatile elements remains weak, but the data suggest that over 2.4 trillion euros of ‘quantitative easing’ (QE) or mass bond-buying since 2015 has dispelled the risk of deflation, or a downward spiral of prices braking economic activity.
At their Thursday meeting in Latvian capital Riga, ‘the governing council will have to assess whether progress so far has been sufficient to warrant a gradual unwinding of our net purchases’ of bonds, top ECB economist Peter Praet said last week.
ECB president Mario Draghi has until now said governors did not even discuss a possible exit from QE at their gatherings.
That makes the topic’s appearance on the agenda, alongside the latest growth and inflation forecasts, an important signal that the end is approaching.
‘They will probably want to take this opportunity while the situation looks relatively calm, while the economy still seems to be growing at a pace that’s above potential’ to wind down purchases, Capital Economics analyst Jennifer McKeown told AFP.
Litany of threats
But policymakers may not yet be convinced that the time is right to remove the training wheels completely.
The current list of threats to the eurozone ranges from the new Italian government’s unpredictable spending policies, which could pitch the bloc’s third-largest economy into a financial crisis, to the prospect of a failure to reach a Brexit deal with London.
An acrimonious end to the G7 summit on Saturday heightened the risk of a tit-for-tat trade war between EU nations and US President Donald Trump, while higher oil prices could weigh on future growth.
Counterintuitively, ‘developments in Italy could make the ECB want to announce the fastest possible exit from QE’ to finally escape northern European suspicions it has prolonged the programme to spare Draghi’s home country financial woes, Bank of America Merrill Lynch analyst Gilles Moec told AFP.
But fears for the sustainability of Italy’s debt mountain have calmed since Economy Minister Giovanni Tria ruled out an exit from the euro Sunday.
Meanwhile, there has been ‘no market response’ to the collapse of the G7 gathering, Capital Economics’ McKeown noted, limiting its importance as the ECB weighs its move.
On the other side of the equation, economist Frederik Ducrozet of Pictet bank noted that ‘recent data on business activity have not been strong enough to rule out further disappointment on the growth outlook – a risk that the ECB would find difficult to respond to’ if it ties itself to a fixed exit strategy from bond-buying.
That means ‘a ‘flexible tapering’ (winding down bond purchases) announcement is more likely than an unconditional commitment to an end date for QE’, on Thursday, he predicted.
Analysts are divided about what exactly such flexibility would look like, and whether policymakers will make their move this month or next.
Draghi could announce a gradual reduction of purchases to zero over several months but leave his options open to increase them again.
Or the ECB could opt for an open-ended extension of bond-buying beyond the current cutoff date of September, but at a slower pace than the present 30 billion euros per month.
How the institution communicates its retreat from QE will be watched closely by investors.
The central bank has long said interest rates will not rise until ‘well after’ the end of bond purchases – meaning whether or not the institution names an end date could have big implications for some investors.