ECB holds off debate on extending QE

Posted on September 8, 2016

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Mario Draghi, ECB president, noted that economic risks remained tilted to the downside

Mario Draghi said the European Central Bank did not even discuss extending its €80bn a month asset purchase programme after concluding that a slight downgrade to its economic forecasts was “not so substantial to warrant a decision to act”.

The ECB kept interest rates on hold and reiterated it would continue its €80bn a month asset purchasing programme until “at least” next March, as it sought to balance lacklustre economic growth against the drawbacks of further monetary policy loosening.

    The ECB’s governing council, meeting on Thursday in Frankfurt, left its benchmark main refinancing rate at zero. The deposit rate remains at minus 0.4 per cent.

    Many economists expect persistently low inflation will eventually force the ECB to extend its quantitative easing programme into the second half of next year — and that the bank may also have to relax rules for buying bonds.

    But the ECB’s wait and see stance pushed the euro up 0.8 per cent against the dollar to $1.1325 and by the same amount against the pound to £0.8490. Foreign exchange traders were already buying the single currency ahead of the ECB statement in expectation that policy would remain unchanged.

    Asked why the bank had not announced more action to tackle low growth and inflation — which the ECB now forecasts to be respectively 1.7 per cent and 0.2 per cent this year — he said the existing monetary policy stance was “fully effective” and there was no increased risk of deflation.

    But Mr Draghi said the bank had instructed internal committees “to evaluate the options that ensure a smooth implementation of our purchase programme” and noted that current low market interest rates already largely reflected “expectations of the continuation of the extraordinary monetary policy support”, including QE.

    “There is no question about the will to act, the capability to act and the ability to do so,” he said.

    Repeating its previous language on the issue, the ECB said in its statement that it was prepared to extend its bond buying beyond March “if necessary and in any case until it sees a sustained adjustment in the path of inflation consistent with its inflation aim”.

    Even continuing with the programme of monthly asset purchases until March may require relaxing internal rules, but officials and public opinion in Germany and elsewhere are deeply wary of such steps.

    Mr Draghi noted that economic risks remained tilted to the downside, with the eurozone’s recovery “expected to be dampened by still-subdued foreign demand, partly related to the uncertainties following the UK referendum outcome, the necessary balance sheet adjustments in a number of sectors and a sluggish pace of implementation of structural reforms.”

    Chart: ECB asset purchase programme

    In quarterly forecasts released on Thursday and only marginally altered since June

    , the bank said it expected inflation to rise to 1.2 per cent in 2017 and 1.6 per cent in 2018. It expected 1.6 per cent growth for both 2017 and 2018.

    In a spirited defence of the bank’s use of negative interest rates in such circumstances, Mr Draghi said it would be “a mistake” to blame the policy for all of the travails of the banking sector. There was little evidence that cash was being hoarded, he added.

    If bank profits had fallen this year it was partly because they were bolstered last year by capital gains resulting from previous ECB policy actions, he said.

    Even though the ECB’s governing council did not debate whether to prolong its asset purchases, they may yet have to address the issue in the coming months.

    Chart: Eurozone GDP growth and inflation

    A scarcity of bonds that fall within the ECB’s rules means any extension of the programme would probably need to be coupled with a change in QE’s design. Mr Draghi himself acknowledged on Thursday that lower interest rates had “clearly restricted” the range of assets that the central bank could buy.

    The biggest changes would involve buying more expensive bonds — raising the threat of losses by the central bank — or switching to a system where the bonds of more highly indebted countries could be bought in more substantial quantities.

    Neither move would be without controversy and either could revive spats between the council’s hawks, led by Bundesbank president Jens Weidmann, and the ECB’s top officials, such as Mr Draghi.

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