ECB Decision Pending

Tomorrow, December 8, 2016, the European Central Bank (ECB) will hold its last meeting of the year and there are a number of issues to address. The ECB’s current quantitative easing program of 80 billion euro in bond purchases per month ends in March 2017. While the ECB could wait another month or two before announcing what, if anything, it will do next, some kind of announcement tomorrow seems likely. The ECB is unlikely to let the market go “cold turkey” and simply end all purchases when the current program expires. More likely, it will “taper” bond purchases, reducing the amount of bonds purchased each month, similar to the Federal Reserve’s (Fed) process as it ended its bond purchase program.

The ECB faces much greater technical hurdles than the Fed did. The ECB can buy bonds from a number of different countries, each with a different degree of creditworthiness. Furthermore, although interest rates have increased in Europe recently [Figure 1], many European government bonds still have negative yields, which could result in the ECB losing money on purchases. The ECB has generated a system of rules regarding which countries it can buy bonds from, and at what yields, to help mitigate its risk of loss. Changes to these rules may be as important as any headline announcements on the size and timing of new bond purchases.

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There is also some question regarding how much assistance the European economy needs. Gross domestic product (GDP) growth, which was only marginal in 2016, is higher at 1.2% for 2017. Inflation also has increased, though at 1.5% remains below the ECB’s 2% inflation target. Given that economic growth remains low, if more stable, and that meaningful political uncertainty persists, the ECB will likely remain fairly aggressive in its policy. “As we can see in the recent Italian referendum, European institutions are not very popular with the European electorate,” said Matthew Peterson, LPL Financial Chief Wealth Strategist. “The ECB is conflicted between wanting to stimulate the economy, and being wary of any political backlash.”

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