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ECB Walks Fine Line as It Prepares to Signal Possible End to Stimulus

Posted by hkarner - 17. März 2017

Date: 16-03-2017
Source: The Wall Street Journal

Even a slight change in message could rock markets and upset the eurozone’s recovery

The headquarters of the European Central Bank in Frankfurt.

FRANKFURT—The European Central Bank is entering uncharted territory as it prepares to signal a possible retreat from its massive monetary stimulus without triggering a violent market reaction.

Bond markets reeled last week on reports that ECB officials had discussed how they might wind down their easy-money policies, which include a giant bond-purchase program and subzero interest rates.

Top officials have since closed ranks around a uniformly dovish message. But as the bloc’s economy strengthens and inflation picks up, investors are watching closely for any sign of a U-turn from Frankfurt.

The risk is that even a small change in communications, in response to improved economic data, could trigger a rout as investors quickly price in higher interest rates. That in turn could upset the eurozone’s recovery.

At a policy meeting last week, ECB officials left the stimulus unchanged but upgraded their economic forecasts and indicated they saw less urgency about taking fresh action to support growth.

Since then, the message has been uniformly “No change .”

“When people talk of regime change, we are not yet there,” Peter Praet, who sits on the ECB’s six-member executive board, said Wednesday at a conference in Frankfurt. Belgian central-bank Governor Jan Smets had a similar message on Friday, arguing in an interview that the ECB hadn’t taken even a small step toward ending easy-money policies.

The comments indicate that the world’s two most powerful central banks remain on divergent paths even as the eurozone economy picks up. In the U.S., the Federal Reserve has signaled its intention to raise interest rates aggressively this year, starting on Wednesday.

But with eurozone inflation now above the ECB’s target and its arsenal of policy tools almost spent, most economists expect the ECB to announce an exit from easy-money sometime over the next few months.

Communicating that change could be precarious, economists said.

The precedent set by the Fed—whose efforts to end its own stimulus prompted a “Taper Tantrum” in mid-2013—is of limited use, economists said.

The eurozone monetary authority faces a particularly delicate task due to high debt levels in countries such as Italy, and the ECB’s use of subzero interest rates, which were never introduced in the U.S., said Frederik Ducrozet, an economist with Pictet in Geneva.

Recent dovish statements by ECB officials appear at odds with evidence of a robust economic recovery in the eurozone. That has prompted calls in Germany, Europe’s largest economy, for a swift exit from the ECB’s stimulus. Eurozone business surveys are at multiyear highs, the bloc’s unemployment rate is at a seven-year low, and inflation is at 2%, slightly above the ECB’s target.

Yet German Bundesbank President Jens Weidmann—a vocal opponent of the ECB’s stimulus—has been conspicuously silent since last week’s decision. In a speech at Wednesday’s conference, Mr. Weidmann contented himself with a single line on monetary policy, urging the world’s central banks not to overstretch.

The ECB argues that the region’s economy remains reliant on a significant amount of monetary stimulus, and that underlying inflation—excluding volatile food and energy prices—is still too weak.

While recent economic indicators have been robust, hard data have yet to improve substantially and inflation remains subdued, Mr. Praet said.

“We don’t see a big surprise in the data,” he said. The bank has changed its communications a little to acknowledge stronger growth, but the recovery remains reliant on easy money, he said.

If the ECB did decide to move toward the exit soon, economists say it might find a propitious window. Global investors are buoyant ahead of expected economic policy changes by the new U.S. administration, and they are taking Europe’s packed election calendar in their stride.

The Fed’s assertiveness on interest rates is likely to further strengthen the dollar against the euro and other currencies, providing cover for the ECB.

But in a sign that investors are sensitive to any talk of an exit from the ECB, the euro rose on Friday and eurozone bonds tumbled on reports that policy makers had considered whether to raise interest rates before ending their bond-purchase program. A person familiar with the matter said there was no substantive discussion of that topic at last week’s meeting.

Some economists argue that the ECB could safely ditch subzero interest rates without rattling markets because of the adverse side effects of that policy, which is seen to crimp banks’ profits. The risk is that markets might see any rate increase as the first in a series.

High debt levels would also magnify the impact of any rate increases by the ECB and other central banks, said Philipp Hildebrand, the former Swiss central-bank chief and current vice chairman of BlackRock Inc.

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