Global markets seem to be obsessed these days with talk of whether and when the world’s central banks will begin tapering―that is, winding down―the bond-buying programs at the heart of their quantitative easing (QE) policies.
In a news conference following yesterday’s European Central Bank (ECB) announcement that it was keeping monetary policy steady, ECB President Mario Draghi repeatedly insisted that there had been “no discussion” by the ECB’s Governing Council about whether to taper down its trillion-euro bond-buying program. The most Draghi would say was that it would “not last forever” and an “abrupt” end to the bond buying “is unlikely.”
The euro went on a bit of a rollercoaster ride as a result, climbing on Draghi’s comments that ECB policymakers did not discuss a QE extension and then falling back when he said there had also been no talk of tapering, either.
Look for ECB to Extend QE in December
In our view, Draghi is being coy. The obvious key message here is that the ECB is not tapering, and any talk of ECB tapering at this time is, as our Chief Investment Officer Krishna Memani calls it, all smoke and no fire.
Rather, Draghi and his ECB colleagues are preparing for their December meeting when, we believe, they will extend QE. We think that could be their last shot before tapering, so they better do it well, which means a long QE extension―nine months, not the six months some market participants are talking about―to prepare the markets in 2017 for tapering in 2018.
There’s a political consideration as well. The ECB probably would like to extend QE beyond the 2017 national elections in Germany, which will likely take place in the fall. So for Draghi and the ECB it probably makes sense to do it when they can, instead of getting into difficult discussions later. The difference between six and nine months is not big after all and, in our view, it would be prudent to err on the dovish side.
Downside Risks to Eurozone Economy?
If there are no major shocks in 2017, the Eurozone economy should continue with its stable growth of about 1.5%-1.7%. Draghi says risks to the ECB’s outlook are to the downside. This may be true but, at the same time, the risks are more balanced now compared with six months ago:
- Commodity economies, including major emerging market economies, are recovering;
- The U.S. economy is regaining momentum in the second half of 2016;
- China looks stable;
- The global economy seems to have stabilized at below-average growth but not too far off its historical average; and
- While the Eurozone was hit by many shocks, most importantly Brexit, it has proven resilient.
On the inflation front, declines in energy prices kept inflation low, even negative at times, but as energy prices rebound so will headline inflation. It will then become more difficult to make a case for easing as time passes.
ECB’s December Case for Extending QE
When we get to December, we believe the ECB will make a multi-pronged pitch for extending QE. First, Draghi will argue that while growth has been stable, the ECB must continue to minimize downside risks. ECB policies – not just QE, as they like to emphasize, but the whole stimulus package – are working, but more is needed to secure the ongoing recovery.
Second, inflation will be low at that time anyway, and core inflation will not be trending up yet. Here again, Draghi and ECB chief economist Peter Praet have previously stated they want a sustainable inflation trend, not just the base effects, so core inflation needs to firm up and get closer to the ECB’s target of around 2%. We do not believe we will see that any time soon.
There is not much upside for the ECB in waiting or doing just a little in December. As time passes, securing a consensus within the Governing Council may prove difficult. The ECB will likely use its last QE bullet wisely in December.
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