The European Central Bank is set to discuss the €60bn question today — how to wean the eurozone economy off quantitative easing.
The fate of the €60bn-a-month programme in 2018 is a big concern for investors. When Mario Draghi gave them the impression last month that the bank was about to tighten policy there was a shortlived jump in government borrowing costs and the euro.
ECB officials later claimed that the markets had misunderstood their chief, but the episode at a forum in Sintra, Portugal, was a demonstration of the perils of sounding bullish, if that implies an end to the extra stimulus that investors have grown used to.
One reason why the issue is so sensitive is that the ECB is widely expected to stop buying bonds at some point next year, because the eurozone economy is doing markedly better than in the past.
So, as the ECB governing council gathers and Mr Draghi meets the press (at 1:30pm), analysts will be on the lookout for clues as to how the bank intends to leave the eurozone’s bond markets, where it has been the biggest player since QE began in spring 2015.
Expect the ECB president to stick to the three themes he emphasised in Sintra: confidence, persistence and prudence.
The eurozone’s central bankers exude confidence that their monetary stimulus is having the desired effect on economic growth. Easy credit conditions have helped create a broad recovery across the region, which has produced about 6m jobs so far.
The governing council may now feel confident enough in the recovery to drop some of the ECB’s more dovish language, specifically a commitment to boost QE should the recovery veer off track.
If such a change were made it is likely to be reflected in the governing council’s statement on interest rates, due out at 12.45pm UK time.
While the recovery has been strong enough for Mr Draghi to declare the threat of deflation dead, inflation is still weak — which partly explains his call in Sintra for “persistence in our monetary policy”.
At 1.3 per cent in the year to June, the headline rate is still well below the ECB’s 2 per cent target.
With wage growth still weak in economies as strong as Germany, there is little evidence that big price pressures will re-emerge soon.
At Sintra, Mr Draghi suggested that the ECB would only reduce the scale of asset purchases once inflation started to pick up.
The whole logic of the QE programme is to reduce the cost of borrowing in the real economy. If that cost and the rate of inflation were to rise at the same time, real interest rates would be largely unchanged. Under such a scenario, the ECB could be able to begin tapering QE without raising the borrowing costs of the eurozone’s households and businesses.
Such reasoning points towards a long, slow taper over the course of next year — but, with 2018 fast approaching, many investors would appreciate more guidance.
There has been speculation that the ECB president may say today that committees of eurozone central bank economists have been asked to come up with a list of options for tapering. If he makes such an announcement, it will raise the chances of a decision on tapering on September 7.
The Sintra incident has stoked concerns of a Fed-style “taper tantrum” in the eurozone. That is a reference to the disruption in the markets in 2013, including a rise in US Treasury yields and the dollar, after the Federal Reserve signalled its plans to draw its QE programme to a close.
Some policymakers are deeply concerned that a mishandled taper will trigger a sharp increase in borrowing costs and a stronger euro, undoing the bank’s work and choking the recovery.
Such worries explain why Mr Draghi is likely to emphasise that the ECB will “need prudence” in removing the stimulus, despite pressure from more hawkish members of the council for greater clarity.
The ECB president faces the unenviable task of not only having to soothe market jitters, but also keeping his council united ahead of what promises to be a testing autumn.