By Tom Fairless
FRANKFURT -- European Central Bank President Mario Draghi
overcame fierce resistance three years ago to roll out a historic
bond-buying program. Ending it could be an even more delicate
task.
On Thursday Mr. Draghi is expected to lay out the ECB's plans to
scale down its bond purchases, known as quantitative easing or QE,
which economists credit with helping to strengthen economic
recovery across the 19-nation eurozone.
Move too quickly, and Mr. Draghi risks an adverse financial
market reaction that could derail the recovery -- and might even
rekindle its sovereign-debt crisis. Move too slowly, and investors
could be left doubting whether the ECB has drawn a line under its
bond purchases.
Investors are on edge. "One loose word could destroy months of
work," said Stefan Gerlach, a former deputy governor of Ireland's
central bank who is now an economist at EFG Bank in Zurich.
The ECB is navigating between a weak outlook for inflation and a
looming shortage of bonds that it can buy under self-imposed rules
for QE. It also faces conflicting political pressures around Europe
to continue to support the economic recovery, or to exit its
stimulus programs soon.
The ECB's dilemma echoes that of other major central banks, led
by the Federal Reserve, which are finally edging toward higher
interest rates after a decade of stimulus measures. Many investors
worry about hidden problems that might come to light as governments
and businesses finally face up to higher interest rates, including
potential asset-price bubbles, and "zombie" firms that survived
artificially on low rates. Eurozone firms and households haven't
reduced their debt in aggregate since 2009, according to
Commerzbank, meaning that many could struggle as rates rise.
How to exit from the EUR2.3 trillion QE program will be the
ECB's fourth momentous decision of Europe's crisis-racked decade
since 2007. It follows emergency lending to banks, its "whatever it
takes" pledge to prevent the collapse of the euro, and the launch
of QE in early 2015 to prevent a slide toward deflation.
Mr. Draghi is expected to try a sleight of hand, telling global
markets that the ECB will extend its bond purchases deep into 2018
while reducing the monthly amounts from EUR60 billion to EUR20
billion or EUR30 billion -- but also trying to convince investors
that nothing has changed.
That would echo a move by the ECB a year ago to reduce the pace
of its purchases while arguing that the QE stimulus policy was
continuing.
If successful, QE's termination would mark a big step in the
eurozone's return to normality. If mishandled, it could leave the
$12.5 billion eurozone economy with fresh chronic problems -- and
with fewer tools to fix them.
Mr. Draghi's task on Thursday is even trickier than the
balancing act that faced the Fed when it wound down its own QE
program almost four years ago. The ECB has had to buy bonds more
aggressively than the Fed to stimulate the eurozone economy,
because economic activity is less sensitive to financial asset
prices than in the U.S., economists say.
Purchases of U.S. government bonds never exceeded their net
issuance, whereas for the ECB, QE is currently seven times bigger
than net issuance of eurozone government debt, according to Torsten
Slok, an economist with Deutsche Bank in New York.
The ECB's balance sheet is also significantly larger as a share
of gross domestic product -- 40% of eurozone GDP, versus 24% for
the Fed. That means the ECB's exit could create bigger ripples than
the Fed's, which triggered a "tantrum" in global bond markets four
years ago.
The ECB faces an additional hurdle: It is running out of bonds
to buy. Policy makers say they are prepared to use up all of the
remaining stock of eligible bonds -- some EUR300 billion -- in a
final effort to drive up stubbornly low inflation.
But top ECB officials are deeply divided over whether to
announce a concrete end date for QE on Thursday, or to leave open
the prospect of a fresh extension.
The ECB's purchases have kept a lid on borrowing costs for
highly-indebted southern European governments such as Italy,
helping to guard against a return of the region's sovereign-debt
crisis. As the ECB exits bond markets, there is a risk the debt
crisis could return.
"The root causes of the sovereign-debt crisis have not yet been
solved in Italy, this is what makes the ECB's exit so complicated,"
said Jörg Krämer, chief economist of Commerzbank in Frankfurt.
Italy's central bank governor Ignazio Visco warned in an
interview last week that it would be "foolish" to fix an end-date
in the face of economic risks that could trigger a sudden change in
the outlook.
Even though the ECB has been extremely careful to prepare the
markets for a policy change, doubts linger over how southern
European countries will adjust to higher interest rates,
particularly as the Fed also moves in the same direction, said Lena
Komileva, chief economist with G+ Economics in London.
Even critics of QE accept that the program has helped boost the
economy, by compressing a range of market-interest rates and
thereby stimulating lending and growth. The region's unemployment
rate has fallen from around 12% to 9% since QE was announced, and
business and consumer confidence are at postcrisis highs.
Jens Weidmann, the German Bundesbank president who publicly
broke ranks to attack QE when it began, might support an extension
of the program this week, the first time he would have done so,
according to a person familiar with his thinking.
The sticking point for the ECB is inflation, its actual target.
Core inflation, which excludes volatile food and energy prices, has
hardly budged since the start of QE, rising to 1.1% from a trough
of 0.6%. The ECB doesn't expect inflation to reach its target of
just below 2% until at least 2020.
Publicly, ECB officials argue that their policies will succeed
eventually in pushing up inflation. But privately, they are divided
over whether QE can ultimately push inflation higher, according to
a person familiar with the matter.
Write to Tom Fairless at tom.fairless@wsj.com
(END) Dow Jones Newswires
October 24, 2017 05:44 ET (09:44 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.