By Tom Fairless
FRANKFURT -- The European Central Bank is expected to extend its
monetary stimulus on Thursday, but it is running out of room to
keep buying bonds, the bank's most important tool for trying to
bolster the eurozone economy.
With the ECB's balance sheet already hitting record highs and
potential problems sourcing enough bonds, some economists and
policy makers say the bank needs to figure out soon how to wind
down its so-called quantitative-easing program.
Any discussion of tapering QE risks spooking investors at a
sensitive political juncture. Four of the eurozone's five biggest
economies, including Italy, look set for major elections next year,
with anti-euro populists on the rise.
In the U.S., bond prices fell sharply and markets became choppy
in 2013 when former Federal Reserve Chair Ben Bernanke suggested
the central bank might slow its bond-purchase program.
"Signaling an eventual tapering of asset purchases now would
almost certainly trigger...a 'taper tantrum' that might jeopardize
the recovery and force the ECB to do more," said Frederik Ducrozet,
an economist at Pictet Group in Geneva.
Italy in particular could quickly run into trouble if the ECB
takes its foot off the gas. Interest payments on the nation's debt,
which is around a third larger than its economy, are likely to
surge if the ECB stops buying it, potentially jeopardizing Italy's
position in the eurozone. Prime Minister Matteo Renzi resigned on
Monday after voters rejected a proposed constitutional
overhaul.
ECB President Mario Draghi has denied repeatedly that policy
makers have even discussed tapering, and stressed that the bank's
stimulus must be preserved for now.
Most economists expect the ECB to announce a six-month extension
of QE on Thursday, probably at the current pace of EUR80 billion a
month. The program had been due to expire in March.
But the purchases can't go on forever because the universe of
assets is limited, and the path toward an exit must be mapped out
early, economists said.
Changing asset-purchase programs is fundamentally different from
tweaking short-term interest rates and takes much longer to
execute, said Stefan Gerlach, deputy governor of Ireland's central
bank until last year.
"For asset-purchase programs, a small modification risks leading
to a devastating jolt to long yields and in bond prices,
potentially triggering financial instability," said Mr. Gerlach,
who is now chief economist at BSI Bank in Zurich.
Top ECB officials have recently highlighted the adverse side
effects of the bank's stimulus policies, signaling that they may be
approaching a turning point. Mr. Draghi warned last week that a
lengthy period of low interest rates created "fertile terrain" for
financial-market risks. In an interview published Nov. 30, the ECB
chief suggested that a slower pace of bond purchases might be
possible in combination with a longer extension.
Even that modest move might be risky, however, because it could
be interpreted by investors as a move toward tapering.
"If the ECB were to commit to a nine-months extension of QE at
EUR60 billion per month...many in the market would see this as a
reduction in stimulus and a form of tapering," said Marchel
Alexandrovich, an economist with Jefferies in London.
Policy makers are likely to be wary of taking such a risk now.
Economic growth remains sluggish, and core inflation -- stripping
out volatile food and energy prices -- was just 0.8% in November,
lower than it was a year ago. The ECB aims to keep inflation just
below 2%.
Jens Weidmann, president of Germany's Bundesbank and long an
opponent of the ECB's bond purchases, called last month for "extra
care" in deploying the bank's stimulus tools. He warned on Monday
that central banks shouldn't use easy-money policies to fight debt
crises or rising populism, signaling he would oppose any move to
support Italy following that country's failed referendum.
Meanwhile, the ECB faces mounting challenges in finding enough
bonds to buy. To extend QE by six months, the bank is expected on
Thursday to change its self-imposed rules, which include strict
limits on the yields and volumes of bonds it can buy.
Each of those changes could be problematic, potentially giving
the central bank too much control over the bond market, or favoring
some nations over others. A jump in bond yields following U.S.
presidential elections has bought the ECB a little time, but not
much. The ECB could turn to other assets, such as bank bonds or
equities, but both could prove controversial.
Mr. Draghi could take a subtle approach to the tapering debate
on Thursday. He could pledge, for instance, to regularly reassess
the pace of bond purchases from the second half of next year. That
way, the ECB chief could raise the possibility that purchases will
slow later next year, without committing himself.
The ECB probably can't delay for long. Mr. Gerlach estimates the
ECB will need more than a year to halt its purchases after
announcing its intention to taper. In 12 months, the eurozone
economy might look very different, particularly if the euro
depreciates further against the dollar and governments in the U.S.
and Europe increase spending.
ECB policy makers "don't want to take any risks right now, but
at some stage they need to look for the beginning of an exit
strategy," said Martin Lueck, chief German investment strategist at
BlackRock Inc.
Write to Tom Fairless at tom.fairless@wsj.com
(END) Dow Jones Newswires
December 06, 2016 11:11 ET (16:11 GMT)
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