What next for Europe as ECB calls time on QE?
Following today’s European Central Bank (ECB) Governing Council meeting, the central bank announced that it plans to extend its quantitative easing programme (QE) from September to December 2018, but with monthly purchases tapered from €30 billion to €15 billion.
It then expects QE to end, although any bonds maturing will be replaced to maintain the net balance held on the ECB’s balance sheet.
The ECB also updated its forward guidance on interest rates, stating that they will remain at current levels at least through the summer of 2019. This is more dovish than we or the market expected.
Since the announcement, the euro has fallen by over a percentage point against the US dollar, while government bond yields have also fallen (i.e. prices risen).
ECB lifts inflation forecasts
In his press conference, ECB president Mario Draghi gave a reasonably upbeat assessment of the economy. While the ECB’s forecast of GDP growth has been lowered for 2018, it remains “solid”, with greater clarity around domestic demand. However, Draghi did highlight increased downside risks emanating from global politics.
On inflation, the ECB has raised its forecast substantially for 2018 and 2019 to account for higher energy price inflation. However, there is still some concern as whether the recovery in inflation (already at the ECB’s target of 1.9%) is sustainable.
How long can interest rates stay in negative territory?
Looking ahead, clarity on the end of QE will end speculation that a further extension was possible, especially to counter the volatility created by the political situation in Italy.
However, keeping interest rates in negative territory for at least another year seems very strange and we struggle to see the justification for such policy, other than competitive devaluation of the euro.
Also, given recent speeches from more hawkish members of the Council including Klaas Knot, we wonder how Draghi has managed to win unanimous support for the dovish policy path set out today.
We suspect tensions will rise further later this year as inflation remains elevated, and the notion of keeping rates on hold for so long will be revisited.
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