ECB Seen Using July Decision to Calm Investors' Taper Temper (1)

Jul 17, 2017 3:55 am ET

(Bloomberg) -- The European Central Bank is on track to unwind its stimulus next year but it’s likely to drag out the process, economists say.

The ECB will probably hold fire this week and wait until September before slowing the pace of its bond-buying program, a Bloomberg survey shows. The rollback is seen starting in January and taking nine months, up from the previously predicted seven months, with future reductions announced one step at a time. Respondents are split on whether officials might set the tone on Thursday by dropping a pledge to boost quantitative easing if needed.

The survey suggests that the Governing Council session in Frankfurt on July 19-20 will largely be a time for discussing how much room there is to pare back stimulus after more than four years of economic expansion. While inflation is still short of the ECB’s goal, President Mario Draghi and some of his colleagues have said in recent weeks that it may be possible to adapt the existing measures without undermining the recovery.

“The ECB is trying to achieve an exit from QE without a tantrum. That means tapering will be slow and that it will continue to signal that rate hikes are some way off,” said Nick Kounis, an economist at ABN Amro. “At the July meeting, the ECB could send a signal that it wouldn’t stand back if financial conditions tightened too much.”

The euro was down 0.3 percent at $1.1439 at 9:46 a.m. Frankfurt time on Monday, after climbing 0.6 percent last week.

One option for policy makers might be a change in the wording on asset purchases, which the ECB says will be increased in size and/or duration if the economic outlook deteriorates. Almost half of economists in the survey said the Governing Council will use Thursday’s meeting to remove that so-called easing bias.

The ECB has already started changing its policy language, saying at last month’s meeting that the risks to economic growth are now “broadly balanced” instead of tilted to the downside, and that officials no longer expect interest rates might be cut again. The wording on QE was left unchanged because policy makers believed altering it could be misperceived as signaling a more fundamental change.

Since then, Draghi has said the ECB might be able to accompany the recovery by “adjusting the parameters of its policy instruments” while keeping its accommodative stance broadly unchanged. That speech, which caused bond yields and the euro to surge, was echoed by Executive Board member Benoit Coeure and French central-bank chief Francois Villeroy de Galhau, who pointed to the ECB’s decision last December to announce a reduction in monthly bond purchases as deflationary risks receded.

Economists increasingly see the ECB keeping to that approach in the future. Rather than announcing a preset path of reductions, 65 percent say officials will scale back QE one step at a time. That’s up from 56 percent who said the same last month.

Draghi has also urged persistence in pursuing stimulus and prudence in signaling its withdrawal, a message repeatedly advocated by Chief Economist Peter Praet, one of his closest colleagues. Praet writes the board’s policy proposals and presents them at each Governing Council meeting.

The ECB remains well short of its goal of restoring inflation to just under 2 percent on a sustainable basis. The rate was 1.3 percent in June and economists forecast it’ll average just 1.6 percent in 2019. Policy makers are especially concerned that slow wage growth is holding down prices.

“The main test is whether improved economic data across the region and a better growth outlook can deliver further labor-market gains, accelerating nominal wage growth, and the continued recovery in firms’ pricing powers,” according to Raj Badiani, an economist at IHS Markit, adding that those are all “key components to ensure that core inflation is elevated to a higher plane.”

Most economists in the survey foresee bond purchases ending by September 2018, and more than two-thirds expect the first deposit-rate increase by the fourth quarter of next year.

That may prove to be optimistic. Governing Council member Ilmars Rimsevics, the head of Latvia’s central bank, said last week that QE could continue “for at least a few years.”

Draghi could sway the debate in August, when he’s scheduled to attend a U.S. Federal Reserve symposium in Jackson Hole, Wyoming. The last time he spoke there, in 2014, he made a last-minute change to his speech that effectively heralded the start of QE.

Three years on, the Fed is planning what should be the final stage of its QE program in shrinking its balance sheet. The U.S. central bank’s post-crisis experience may give Draghi some lessons on how the ECB should approach its own end-game.

“The ECB will be mindful that the announcement to gradually reduce asset purchases does not provoke market expectations that rate hikes are imminent,” DekaBank economist Kristian Toedtmann said. “This happened in the U.S. when Bernanke announced tapering in 2013 and yields of long-term bonds rose considerably. If this happened in the euro area, financial conditions would tighten much more than intended.”

(Updates with euro in fifth paragraph.)

©2017 Bloomberg L.P.