The ECB’s options vis-a-vis its bond buying program

The following is an interesting take on the options available to the ECB on ways to stimulate economic growth and curate inflation in the Eurozone.

The European Central Bank is likely to maintains its stimulus policy on Thursday, given the spread of risks stemming from the global trade conflict.

Last month, with inflation rebounding and with employment levels at a record high, the ECB decided to end its $3.0 trillion (2.6 trillion euro) bond buying scheme by the end of this year. Still, faced with a growing slowdown and with an escalating trade war, the central bank had promised record low interest rates at least through next summer. This had suggested it would wean off the stimulus from the Eurozone in small increments so that there is less turbulence in the recovery of inflation.

So as to not upset the market’s expectations for a late 2019 rate hike, ECB President Mario Draghi could potentially argue that little has changed since its June 2018 meeting, even if recent indicators point to a persistent slowdown.

“In the near term, our sense is that downside risks have intensified,” said Morgan Stanley in a note to clients.

In June 2018, the composite PMI indicator took a downward turn, indicating that consumer confidence in the economy had eased; mirroring the trend was the German IFO business climate index which fell in July. All of these point to a persistent slowdown in the economy which could compel the ECB to once again lower its growth projections in September.

On the other hand, the pace of expansion is still above what is seen as the bloc’s potential growth rate, thus the ECB could argue that the eurozone will continue to create jobs and eventually generate inflation, and meet its inflation target.

“As long as the trade tensions do not escalate into an outright trade war, we see no reason for the ECB to change its June guidance,” said Florian Hense, economist with Berenberg.

The ECB’s decision on hiking interest rate is due today at 1145 GMT, followed by Draghi’s 1230 GMT news conference.

Although it is unlikely that the ECB will take any firm decision, it could however discuss tweak to its guidance as well as revise the rules on how it invests cash from maturing bonds. In this regard, in June the ECB had stated, it “anticipates” its bond buying program to end in December.

Again, such a move may not be seen as necessary since the markets have fully factored in the end of the bond buying this year; the bar for another extension is seen as exceptionally high.

Since the fresh buying program is set to end this year, the reinvestment of cash from expiring bonds will become a more significant policy tool; Draghi has also said that updated rules will be issued in the coming months on how to spend this cash.

A key challenge is that the remaining maturity of the bond pile declines over time, so the ECB will have to decide whether to target longer-dated bonds or to accept the natural ageing of its portfolio.

Yet another option could be to increase the ECB’s flexibility in reinvestments as current rules on the timing of buys could tie the bank’s hands too much, forcing it to make large purchases in a given market when smoother buys would be more appropriate.


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