ECB to stand fast as squeeze on bond-buying nears

The European Central bank will drop hints and play for time at its meeting Thursday, analysts predict, saving a big announcement on ending its easy-money policy for October as it strives to balance conflicting pressures.

Two major factors are squeezing the ECB: a stronger euro and still-sluggish inflation could justify prolonging its quantitative easing (QE) bond-buying programme, but it is approaching the legal limits of the scheme and may be forced to wind it down.

"ECB President (Mario) Draghi for the first time ought to hint at a reduction of the central bank's bond purchases in 2018" on Thursday, Commerzbank chief economist Joerg Kraemer said.

After the last meeting, Draghi was deliberately vague about the date when a concrete decision would fall, promising an update in the "autumn" -- which most analysts have taken to mean September or October.

Along with low interest rates and cheap loans to banks, the ECB's 60 billion euros ($71.5 billion) of bond purchases per month are designed to encourage growth in the 19-nation eurozone, pushing inflation towards its target of just below 2.0 percent.

Data that will feed into the ECB staff's September forecasts for the coming years have yet to show price growth on track.

The projections will reflect the accelerating economic growth of 0.6 percent seen in the single currency area between April and June.

But August figures from statistics agency Eurostat showed inflation at 1.5 percent, well short of the central bank's goal.

Meanwhile, the "core" measure highlighted by ECB policymakers, which excludes volatile food and energy prices, reached just 1.2 percent.

One reason is that the euro has appreciated against other currencies as the recovery gathers pace, braking price growth as imports become cheaper.

"The appreciation of the single currency since the ECB's last meeting has strengthened the case to delay the formal announcement of tapering until October," Capital Economics analyst Jennifer McKeown said.

Nevertheless, "even at current levels, the euro should not do too much damage to the growth or inflation outlook," she added.

- Why now? -

Following July's meeting of the governing council, Draghi emphasised the need to be "persistent and patient" in the face of unresponsive inflation, suggesting that an end to QE will be drawn out.

Policymakers still see slack in the eurozone economy, and have pointed to slow wage growth linked to still-high unemployment and underemployment in some member countries as the biggest factor holding back inflation.

Prolonging the ECB's intervention could support growth and inflation for longer, making a smooth withdrawal more certain.

But the bank is running up against the limits set in its own rules and insisted on by European and German courts, which bar it from buying more than 33 percent of any one country's debt.

Coveted German bonds have also become scarce on the market, making it difficult for the ECB to buy in proportion to the "capital key", or the share of its capital contributed by each eurozone nation.

"It appears the lone viable option is to accept the legal limits and gradually scale back the purchases next year," Commerzbank's Kraemer said.

- Step by step -

Almost 80 percent of respondents in a Bloomberg News survey of economists agreed that the ECB would reduce its monthly purchases from January.

A large majority of analysts also expect the bank to announce only one tapering "step" at a time, leaving its options open to boost QE again if the impact on the economy and the inflation outlook is too severe.

"The ECB will proceed very cautiously and retain a maximum of flexibility in all its moves," Kraemer predicted.

Eurozone government bond yields and the euro exchange rate against the dollar both rose after an upbeat June speech from Draghi on the economic recovery -- just the latest reminder of how carefully the central bank chief must tread to avoid market upsets.

Rather than scrambling to react to a big policy announcement Thursday, ECB observers will therefore likely be left sifting the president's words for what to expect in six weeks' time.

© 2017 AFP