Mario Draghi, President, ECB (Source: Bloomberg)

Draghi Calls for Caution as Flagship Stimulus Heads to Exit

(Bloomberg) -- Mario Draghi warned that the European Central Bank will remain cautious even as he put his signature stimulus measure on the road toward an exit.

Starting in January, the ECB will take a step toward ending one of its more controversial tools by cutting monthly purchases of public and private debt to 30 billion euros ($35 billion), or half the current pace. The shift in stance comes six years into Draghi’s presidency, a new phase after his unprecedented actions to prevent the breakup of the euro area and stave off deflation.

The decision “reflects growing confidence in the gradual convergence of inflation rates towards our inflation aim on account of the increasingly robust and broad-based economic expansion,” he said in a press conference after Thursday’s Governing Council meeting. “At the same time, domestic price pressures are still muted overall, and the economic outlook and path of inflation are conditional on support from monetary policy.”

While Draghi toned down his language, saying the euro area still needs “ample” stimulus instead of the “substantial” used in previous statements, he emphasized the need to tread carefully as long as consumer prices remain weak. There will not be a “sudden end” to the program, and the reduction is “not tapering,” he said. The updated plan will take total QE holdings to at least 2.55 trillion euros.

Investors read the decision as dovish, sending the euro and bond yields lower. The single currency was down 0.9 percent at $1.1704 at 5:07 p.m. Frankfurt time.

The nine-month extension “serves to push rate-hike expectations really far out,” said Holger Sandte, chief European analyst at Nordea in Copenhagen. “One can justify that by the inflation outlook. The task of somehow making monetary policy more normal, that will then fall to Draghi’s successor in late 2019.”

The ECB president said the decision wasn’t unanimous. A key point of dissent among some policy makers has been whether or not to set a firm end date for purchases, after some ECB officials have expressed concern that there is little more than 200 billion euros worth of space left before they run into constraints.

“I would characterize the discussion as ranging between consensus, broad consensus on some issues and large majority on others,” Draghi said. The decision to keep purchases effectively open-ended was taken by large majority, he said.

Reinvesting Debt

Draghi did stress that reinvesting proceeds from maturing assets is an “important” part of QE policy, signaling it may cushion some of the effects of reducing net purchases. The ECB announced in a press release that it would publish reinvestment amounts monthly.

Even with that source of support, the ECB head highlighted additional risks including the strength of the euro, which has risen almost 12 percent against the dollar this year, potentially depressing price pressures and undermining export competitiveness. He also reiterated that governments need to step up their structural reforms “substantially.” That could be a key risk as monetary stimulus is pulled back.

Investors have for months attempted to guess the central bank’s next move, with the drawn out decision-making process highlighting the struggles policy makers face in balancing a stimulus exit with the need to return inflation toward their objective. 

Even after becoming the first major central bank to charge banks for deposits and embarking on a quantitative-easing program, inflation remains far from the goal of just below 2 percent. That partly reflects a phenomenon of lackluster price growth faced by developed economies across the globe, which U.S. Federal Reserve Chair Janet Yellen has called a mystery.

The ECB began large-scale asset purchases in March 2015 -- more than six years after the Fed started its first program. Germany’s Bundesbank has been outspoken against the measure even before it began, arguing that it reduces incentives for governments to make their economies more competitive.

To read more about the history of the ECB’s QE program, click here.

The latest reduction is the second after the program was slowed this April, and it is widely expected to constitute the final leg of QE as the ECB’s capacity to provide more stimulus becomes increasingly constrained by self-imposed rules, which include not buying more than a certain share on individual countries’ debt.

Draghi pushed back against that argument, saying the program is flexible enough.

“The question is: who is going to call Draghi on the scarcity that dare not speak its name?” said Richard Barwell, an economist at BNP Paribas Asset Management, formerly BNP Paribas Investment Partners, in London.

©2017 Bloomberg L.P.

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