ECB: To QE, or Not to QE?

The market is looking for the European Central Bank (ECB) to provide greater clarity on the continuation of its quantitative easing (QE) policy at its meeting on September 7. Although its current policy of purchasing 60 billion euro in bonds every month is slated to end this December, it’s almost inconceivable that the ECB will completely stop buying bonds after that.

Why? Inflation has been stubbornly low in Europe, and boosting inflation to 2% is one of the ECB’s stated goals (see figure below). Per Matthew Peterson, Chief Wealth Strategist, “Interest rates in Europe are stuck in negative territory, and inflation touched the 2% target with the ECB sticking to its existing policy.” However, inflation has since moved back to 1.5%, and the euro has been strengthening, which will put further downward pressure on inflation, and by extension keep interest rates lower for longer. Recent ECB meeting minutes suggest that at least some people at the bank are worried that recent strengthening of the euro may make companies less competitive in the global market. According to Peterson, “The euro will react negatively to any mention of its recent strength. Then again, it will likely rally if there is no mention at all. The ECB is walking the narrowest of tightropes when it comes to the euro.”

The likely scenario is that the ECB will continue to buy bonds with scheduled reductions in the monthly purchase amount in a process identified as “tapering.” One reason this so-called “tapering” process is likely is that the ECB is literally running out of bonds to buy. The bank has set limits for itself regarding how much of any one country’s bonds it can purchase and at what interest rates it will buy them. Currently, the ECB is having difficulty finding available bonds that meet all of its criteria, as it already owns a significant portion of many countries’ outstanding bonds (see figure below).

While we think that the ECB will taper purchases, it is unlikely to announce a definitive end to QE. Politically speaking, it would be very difficult for the ECB to restart its QE policy, should it need to, if it stops buying bonds altogether at the end of this year.

But regardless of whether the announcement occurs in September or at its October 26 meeting, the ECB is a long way from raising interest rates and shrinking its balance sheet, at least until 2019—more likely 2020.

 

IMPORTANT DISCLOSURES

The economic forecasts set forth in the presentation may not develop as predicted.

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