Europe's Central Bank Faces Decision Time in 2018

(Bloomberg View) -- Mario Draghi had better enjoy his winter break. Entering the home stretch of his eight-year term, the European Central Bank president unveiled a big jump in the growth forecast and told reporters he's increasingly confident in the outlook. His demeanor seemed almost relaxed, winding down for the year.

It won't last.

The relatively upbeat outlook foreshadows a watershed moment coming at officials next summer: a likely decision to retire quantitative easing and an inevitable squabble about what follows it.

Draghi was confident that the inflation target of close to but just below 2 percent would be reached, thanks to a more vigorous expansion and a firming labor market. If it sounds like you have heard this story before, well, you have. It's the main tension in monetary policy around the globe: low and falling unemployment and a synchronized global expansion -- and yet price increases in the major economies are modest, to say the least.

In the euro region, inflation will dip before slowly picking up again, according to projections released at the ECB's governing council meeting Thursday. It will average just 1.7 percent in 2020, the year after Draghi leaves office. (His term cannot be renewed.) Gross domestic product forecasts got a jolt: to 2.3 percent next year compared with a previous prediction of 1.8 percent.

Perhaps Draghi seemed mellow because the big decision on what to do with QE was taken last meeting. Asset purchases will be scaled back to 30 billion euros a month through September. What happens then is the next tension point. Although inflation is only slowly clawing back, it's hard to justify QE beyond September while being so positive about growth. I'd wager that's the end of it.

But with inflation only at 1.7 percent that far out into the future, it's equally hard to be particularly confident about what to do if the economy keeps humming along in that time. The ECB's official line is interest rates will stay at present levels -- zero, basically -- until after the end of QE. If QE ends in September, and inflation is only 1.7 percent in 2020, then that is a long period of expansion for rates to be untouched.

If it all plays out, the euro zone will bask in a bit of a sweet spot for a few years. More likely is that something will give. I sure hope that the world's central bankers solve that inflation mystery before 2020. That is a long time for a file to be open.

In the meantime, let's give the euro region its due. Often caricatured as lumbering and sclerotic, it's been one of the big growth surprises this year. That is, along with Japan, another onetime bad boy that's seen the light.

Funny what a synchronized upswing can do.

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Daniel Moss writes and edits articles on economics for Bloomberg View. Previously he was executive editor of Bloomberg News for global economics, and has led teams in Asia, Europe and North America.

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