By Frances Coppola
According to the ECB announcement, from January 2018 onward the quantity of assets purchased per month will be cut in half, from €60 billion to €30 billion. But the ECB stopped short of announcing a formal end date for QE, saying that purchases would continue until the end of September 2018 "or beyond," depending on the outlook for inflation, and could resume if the outlook worsened.2
The ECB also stuck to its "lower for longer" line on interest rates, saying that interest rates will not start to rise until after QE has completely ended.3 Further, the ECB will continue to purchase bonds to replace previously purchased bonds that mature: this ensures that the value of QE purchases does not fall as bonds reach their maturity date.4 This contrasts with the U.S. Federal Reserve, which is gradually reducing its bond holdings from its (now ended) QE programs by allowing bonds to mature without replacement. The ECB's stance reflects concern that sudden ending of QE (or too-sharp tapering), or premature interest rate increases, could cause the euro's exchange rate to appreciate, further dampening inflation that is already well below the ECB's 2 percent target.5
For much of 2017, the euro's exchange rate has been rising against other major currencies, reflecting the Eurozone's unexpected economic recovery.6 The Eurozone's recovery has raised expectations that the ECB would soon end QE and start raising interest rates. ECB policymakers have made it clear that interest rates would not start to rise before the end of QE,7 but some analysts expected QE to be brought to a complete end by mid-2018, clearing the way for interest rate increases to start in the second half of the year.8
The problem for policymakers, however, is that the rising euro exchange rate depresses the prices in Euros of imports, including essential commodities such as oil and foodstuffs, which are priced in U.S. dollars.9 This is one of the factors currently keeping inflation below the ECB's target of "below, but close to, 2 percent." Despite the economic recovery, Eurozone inflation has remained at around 1.5 percent for most of 2017 and shows no signs of increasing.10 If the ECB suddenly ends QE or raises interest rates, the euro's exchange rate could rise sharply, depressing import prices even more and causing Eurozone inflation to fall.
Because of its single mandate, the ECB's primary concern is returning inflation to target, unlike other central banks such as the Fed or the Reserve Bank of Australia (RBA), for which unemployment and (in the RBA's case) economic growth are also important. For the ECB, therefore, a monetary policy decision that caused inflation to fall even further below target due to a sudden spike in the euro's exchange rate could be regarded as failing to meet its mandate.
QE is Being Reduced, Not Tapered: No Definite End Date
ECB policymakers considered several options for reducing QE:
The ECB opted for "lower for longer" to avoid disruption to financial markets and a spike in the euro exchange rate. Policymakers also debated whether to set a clear end date for QE, but chose to keep the end date open.11 The President of the ECB, Mario Draghi, commented in a press conference after the announcement that the decision shouldn't be called "tapering": it simply sets QE at the level policymakers regard as right for the Eurozone economy at this time.12
However, although a majority were in favor of keeping the end date open, dissenting voices included Jens Weidmann, the head of Germany's Bundesbank, who said he would have preferred a clear end date. Many German economists have opposed QE and expressed a desire for higher interest rates to support German savers.13
For businesses, the ECB's "lower for longer" decision provides some insight regarding the path of monetary policy well into 2018. The euro's exchange rate fall may provide short-term relief to Eurozone exporters and international businesses paying suppliers in euros. However, continued economic recovery in the Eurozone could cause the euro exchange rate to strengthen again. Businesses may wish to keep a close eye on international economic and policy developments, and maintain careful FX risk management strategies.
With 17 years’ experience in the financial industry, Frances is a highly regarded writer and speaker on banking, finance and economics. She writes regularly for the Financial Times, Forbes and a range of financial industry publications. Her writing has featured in The Economist, the New York Times and the Wall Street Journal. She is a frequent commentator on TV, radio and online news media including the BBC and RT TV.
1. “EUR to USD exchange rate,” Bloomberg; https://www.bloomberg.com/quote/EURUSD:CUR
2. “Monetary policy decisions,” October 26, 2017, European Central Bank; https://www.ecb.europa.eu/press/pr/date/2017/html/ecb.mp171026.en.html
5. “ECB’s Draghi faces challenge in putting the brakes on the euro,” Financial Times; https://www.ft.com/content/aee4861a-b591-11e7-a398-73d59db9e399
6. “Eurozone’s economic recovery becomes surprise economic story of 2017,” Financial Times; https://www.ft.com/content/8db37b0a-46be-11e7-8519-9f94ee97d996
7. “Maintaining price stability with unconventional monetary policy measures,” Peter Praet, European Central Bank; https://www.ecb.europa.eu/press/key/date/2017/html/ecb.sp171002.en.html
8. “ECB hints at ‘lower for longer’ bond-buying plan,” Financial Times; https://www.ft.com/content/6374d626-a9de-11e7-ab55-27219df83c97
9. “The exchange rate and inflation,” tutor2u economics; https://www.tutor2u.net/economics/blog/revision-the-exchange-rate-and-inflation
10. “Inflation in the Euro area,” Eurostat; http://ec.europa.eu/eurostat/statistics-explained/index.php/Inflation_in_the_euro_area
11. “ECB Sees Option for Ending QE With Short Taper In 2018,” Bloomberg; https://www.bloomberg.com/news/articles/2017-10-26/ecb-is-said-to-see-option-for-ending-qe-with-short-taper-in-2018-j98rkvcn
12. “Press Conference, October 26, 2017,” European Central Bank; https://www.ecb.europa.eu/press/pressconf/2017/html/ecb.is171026.en.html
13. “Jens Weidmann takes aim at ECB decision on extending QE,” Financial Times; https://www.ft.com/content/485e1d66-bb13-11e7-9bfb-4a9c83ffa852