ECB To Take Tapering Route Beyond March 2017

The European Central Bank surprised markets on Thursday when it announced that bond purchases will be extended till the end of next year, which is longer-than-expected, but its pace will ease after March.

The central bank left its key interest rates unchanged for a sixth consecutive session, which was the final one this year, and retained its asset purchases of EUR 80 billion a month till March next year, but decided to reduce the size beyond that point to EUR 60 billion a month till December 2017.

Initial reactions suggested that economists and markets were be perplexed by the decision, wondering whether the ECB President Mario Draghi delivered more than they expected, in contrast to last December.

Draghi's comments at the customary post-decision press conference, set to begin at 8.30 am ET, will be closely scanned for more clarity. He will likely face intense questioning on the 'no' vote in Italy's referendum and the country's subsequent request for more time to rescue the troubled Monte dei Paschi bank.

The Governing Council, led by Darghi, kept the refi rate unchanged at a record low zero percent in the policy session held in Frankfurt.

The deposit rate was held steady at -0.40 percent, and the marginal lending facility rate at 0.25 percent. The rate decision was in line with economists' expectation.

"The Governing Council continues to expect the key ECB interest rates to remain at present or lower levels for an extended period of time, and well past the horizon of the net asset purchases," the bank said.

The three rates were previously lowered in March, when the size of monthly asset purchases was also boosted by EUR 20 billion.

The bank also decided to continue its purchases under the asset purchase programme, or APP, at the current monthly pace of EUR 80 billion until the end of March 2017.

From April 2017, the net asset purchases are set to be carried out at a monthly pace of EUR 60 billion until the end of December 2017, or beyond, the bank said. They will be continued, if necessary, until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim, the ECB added.

"If, in the meantime, the outlook becomes less favorable or if financial conditions become inconsistent with further progress towards a sustained adjustment of the path of inflation, the Governing Council intends to increase the programme in terms of size and/or duration," the ECB said in a statement.

Economists had widely expected the bank to extend the asset purchases by six months beyond March 2017, but retain the size of the programme unchanged. They had also said that the bank was unlikely to even mention any scale back of asset purchases, also known as 'tapering', given the heightened political uncertainty.

"Even without calling this tapering, the ECB just announced tapering. It is the combination of extending and tapering that we thought would not yet happen as it could risk an unwarranted increase in bond yields," ING Bank economist Carsten Brzeski said.

"A compromise resulting from increased pressure from the ECB hawks to stop or at least reduce QE. Whether it was a wise decision or whether the ECB could end up in a taper tantrum like the Fed did in 2013 remains to be seen."

The net purchases will be made alongside reinvestments of the principal payments from maturing securities purchased under the APP, the bank said.

The Governing Council also decided to change some of the parameters of the APP to ensure the continued smooth implementation of the Eurosystem's asset purchases, the ECB said. These will be communicated at today's press conference and in a separate press release.

"As it had always been expected to taper after September, the decision to slow the pace from March implies a slightly less supportive stance than had been assumed," Capital Economics economist Jennifer McKeown said.

"In all, we see a significant chance that the ECB will have to increase the pace of its asset purchases again next year. And even if it does not, policy will be far more supportive than in the US, leading the euro to depreciate further."