Photo: ralph orlowski/Reuters
ECB Extends but Scales Back Stimulus, Whipsawing Markets
Bank’s move to buoy Europe’s economy comes days before Fed is expected to raise interest rates in U.S.
By Tom Fairless
FRANKFURT—The European Central Bank prolonged its extraordinary lifeline to weak eurozone economies on Thursday, just days before the U.S. Federal Reserve is expected to move in the opposite direction and raise interest rates.
That divergence, along with difficulty in reading the nuances of the ECB’s action, caused investors to initially boost the euro before sending it lower as U.S. equity markets hit record highs.
The ECB surprised markets by saying it would slow the pace of its asset purchases, sparking a debate over whether the ECB had started down the path toward ending its monetary stimulus.
Such a move—swiftly denied by the ECB—might be welcomed by some of the bank’s top officials, who are eager to signal an eventual exit.
Instead, the ECB’s decision was mostly taken as a sign the eurozone badly needs the type of support that the Fed next week could begin removing from the U.S., amid evidence and expectations of solid economic growth there.
Outside the U.S., many investors fear that monetary authorities are running out of tools to bolster weak economies after years of aggressive stimulus measures. In Europe and Japan, central banks have faced criticism over their use of negative interest rates, and questions over the effectiveness of bond-purchase programs. The Bank of Japan in September said it would shift the focus of its monetary stimulus from expanding the money supply to controlling interest rates, a decision seen as a tacit admission that it had reached the limits of its bond purchases.
The ECB said on Thursday it would extend its so-called quantitative easing program by nine months, until at least the end of next year, taking its total size above €2.2 trillion ($2.36 trillion).
But starting in April, the bank will reduce the value of securities it buys per month to €60 billion from €80 billion.
Investors had considered such a move unlikely, betting that the ECB would continue to buy bonds at the current pace for at least another six months. Financial markets initially reacted negatively, with the price of shares and bonds falling sharply, and the euro rising against the dollar. Markets later reversed much of that fall.
The ECB’s decision to slightly lift its foot off the gas, as some saw it, comes despite sluggish growth and mounting political uncertainty across the 19-nation eurozone, which faces a string of major elections next year and fallout from Italy’s rejection of constitutional changes earlier this week. The move is likely to have been backed by some hawkish members of the central bank’s 25-member governing council, who have earlier signaled they seek a clear path out of the bank’s easy-money policies.
Investors, applauding the ECB’s commitment to keep helping eurozone economies, also showed continued confidence in the U.S. economy, which has already been lifted by the prospect of tax cuts and fiscal spending under President-elect Donald Trump.
“There are many things that look positive to investors now,” said Peter Costa, president of Empire Executions Inc., a New York trading firm.
Fed officials are likely to raise short-term interest rates next week for the first time in a year amid signs of an improving labor market and rising wages. They also are apt to signal they expect to lift borrowing costs gradually next year and could release slightly more upbeat economic projections, underlining the different paths of the world’s two most important central banks.
The Dow Jones Industrial Average, the S&P 500 and the Nasdaq Composite closed at fresh highs Thursday, a day after posting their biggest gains since the presidential election.
Lower bond prices in the eurozone rippled into the U.S. bond market, with the yield on the benchmark 10-year U.S. Treasury note rising to 2.391% from 2.347% Wednesday. Yields rise as bond prices fall.
The bond market had rallied a day earlier as investors anticipated the ECB would extend its bond buying beyond March.
ECB President Mario Draghi took pains at a press conference Thursday to stress that the bank’s decision didn’t amount to tapering, or winding down, the bank’s stimulus. He warned that inflation in the eurozone remained too weak and said the ECB would keep buying bonds for some time.
“There is no question about tapering,” Mr. Draghi said. “Tapering has not been discussed today.”
Many investors concluded that the net effect of the ECB’s new stance was continued central-bank support. “It took everyone a bit of time to make their maths. They’re actually going to buy more than expected,” said Olivier de Larouzière, head of interest rates at Natixis Asset Management.
Massive central-bank buying has helped buoy markets in recent years, and investors keep buying on the belief that such stimulus will continue. But more recently, investors have debated whether the ECB would begin to taper its aid in light of a rosier economic picture and concerns over potential side effects of its historically loose monetary policy.
On Thursday, investors decided the ECB, for now, wasn’t looking to turn off the taps.
The prospect that the ECB will keep its stimulus running while the Federal Reserve is poised to raise interest rates sent the euro sharply lower on the day. The euro fell 1.5% to $1.0604 late in the European afternoon, having traded as high as $1.0874 earlier in the day.
Still, many investors weren’t convinced by Mr. Draghi’s arguments. At times on Thursday, the ECB chief veered into semantic gymnastics in an apparent effort to avoid the kind of “taper tantrum” seen in the U.S. in 2013, when the Fed suggested it might wind down its own bond-purchase program.
True tapering, Mr. Draghi argued, would involve gradually reducing the pace of bond purchases to zero. That move wasn’t discussed “and is not even on the table,” he said.
“This was a taper, as much as [Mr. Draghi] wants to deny it,” said Tim Graf, European head of macro strategy at State Street in London. But Mr. Graf welcomed said the ECB’s decision to extend its purchases for longer than expected would postpone any fresh debate on the QE program until after key European elections next year.
“The big Christmas present was time,” Mr. Graf said.
Mr. Draghi said the ECB’s decision had received “very, very broad consensus” from the bank’s 25-member governing council. Top ECB officials have been raising concerns about the adverse side effects of the bank’s easy-money policies. Bundesbank President Jens Weidmann, long an opponent of the ECB’s bond purchases, voted against Thursday’s decision.
“This is a step in the right direction,” said Clemens Fuest, president of Germany’s Ifo economic institute, a prominent critic of the ECB’s stimulus policies.
Michael Heise, chief economist at Allianz SE in Munich, pointed to the ECB’s statement that it could accelerate its bond purchases again if needed. That “can’t be described as tapering,” Mr. Heise said.
Others were less convinced. “Today was a missed opportunity to provide some sort of support to the market into a very uncertain political calendar in 2017,” said Patrick O’Donnell, an investment manager at Aberdeen Asset Management.
The ECB also announced changes to the design of its QE program on Thursday, to ensure it can continue to find enough bonds to buy. Mr. Draghi said that from January the ECB could start buying debt that yields below the minus 0.4% interest rate it pays on commercial bank deposits, something its own rules had barred it from doing. That move was aimed at addressing a scarcity of German bonds. And Mr. Draghi said that the ECB would start buying bonds with maturities of one year, down from the previous minimum maturity of two years.