(Economist) The European Central Bank starts its exit from quantitative easing

(Economist)

WINDING down quantitative easing (QE), the enormous bond-purchases many central banks have undertaken since the financial crisis, is a delicate operation. In 2013 the news that America’s Federal Reserve was merely thinking of reducing QE set off a “taper tantrum”: the bond markets were scared and yields spiked. By contrast, the announcement by the European Central Bank (ECB) on October 26th that at the start of 2018 it would cut its monthly purchases to €30bn ($35bn) from the current €60bn, and continue at that pace at least until September, met a muted response in the markets. The euro fell by only 0.5% against the dollar. Europe’s main share indices rose by a smidgen.

The mild reaction is explained largely by the ECB’s efforts to prepare the ground. In the press conference after the decision, Mario Draghi, the central bank’s head, in a self-congratulatory moment, called the minimal market impact proof of the ECB’s “really effective” communication. The scale and duration of the continuing purchases indeed fell exactly where analysts had anticipated. But this does not make the decision any less important.

The euro area’s economy, after all, is not yet in robust shape. To be sure, there are encouraging signs. Real GDP growth ticked up to 0.7% (quarter on quarter) in the second quarter, from 0.6% in the first. The ECB’s latest bank-lending survey shows that demand for loans is on the rise. But even these improving symptoms are partially predicated on continued easy monetary conditions.

More concerning for a central bank that, unlike the Fed, is required to focus solely on inflation, the euro area’s inflation rate remains a fair way below the ECB’s target of just below 2%. The ECB in fact predicts that inflation will decrease, from 1.5% this year to 1.2% in 2018, mostly because of falling energy prices, before rising only to 1.5% in 2019. Why, then, start tapering now?

Mr Draghi faced two related constraints. Hawks on the ECB’s Governing Council, many of whom opposed QE in the first instance, have long been pushing for it to be unwound. And according to the ECB’s self-imposed rules for QE—it purchases the sovereign bonds of euro-zone countries in proportion to their economic size—it would soon have run out of bonds to buy. Although Mr Draghi remained coy on the composition of the reduced purchases, saying it had not been discussed, markets expect him to cut the purchases of sovereign bonds by more than those of corporate debt.

Policy remains super-easy: the ECB will still be buying. And Mr Draghi struck a doveish note by emphasising two other elements of the ECB’s decision. First, the central bank will reinvest the proceeds from maturing bonds. Its vice-president, Vitor Constâncio, said this would amount to “billions” monthly. (The bank promised to start publishing information on these redemptions monthly, starting on November 6th.) Second, it committed itself to keeping rates low well beyond the end of QE (its main refinancing rate is zero and its deposit rate negative).

Mr Draghi has heralded the most gradual of exits from QE, and it seems that markets have understood that. Yet he is not yet off the hook. As QE unwinds, he will still have to take care to avoid tantrums in future.