The headquarters of the European Central Bank (ECB) stands in Frankfurt, Germany. (Photographer: Ralph Orlowski/Bloomberg)

Mission Accomplished for the ECB, for Now

(The Bloomberg View) -- The European Central Bank has said it intends to end its bond-buying program at the end of this year. It was the right decision. The aim of the program was to stave off the threat of deflation, and that has been done. Nonetheless, risks remain, and the central bank can’t afford to ignore them.

The euro-zone economy has come a long way since the ECB first launched QE in January 2015. Inflation has gone up from minus 0.6 percent to 1.9 percent — in line with the central bank’s target of close to but below 2 percent. Core inflation, which omits volatile items such as energy, is lower, but this too is changing. In the first quarter of the year, compensation per employee across the currency union rose at a yearly rate of 1.9 per cent, suggesting that inflationary pressures are growing.

The ECB intends to reduce its monetary stimulus rather than end it altogether. It will reinvest the proceeds from maturing bonds, which will help to keep yields down. And it has promised to keep its policy rates at the current ultra-low level at least until the end of next summer. Finally, the central bank has said it might restart asset purchases should inflation subside again. Investors took this on board: European sovereign bond yields fell sharply on the announcement, and the euro tumbled against the dollar.

Tightening policy gradually and tentatively is wise. The European economy is going through a rough patch, thanks partly to weak global demand. The ECB believes that is temporary, but the outlook isn’t clear. Trade tensions could worsen and lead to a full-blown trade war, hitting exports and business confidence. Italy’s new populist government has unnerved investors with a long list of lavish promises. These tensions have eased in recent days, but could still spiral out of control.

For three years, the ECB has allowed investors to overlook the fragilities in the public finances of several member states and the flaws in the monetary union. Governments must now learn to do without the central bank’s support.

©2018 Bloomberg L.P.

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