As widely anticipated, this morning the ECB announced a reduction in its monthly pace of asset purchases to €30 billion a month starting January 2018 (current pace: €60 billion/month). Moreover, the ECB also announced that asset purchases would end in September 2018 or beyond, conditional on how Governing Council judged the evolution of inflation toward target. Similarly, principal payments from maturing securities will continue to be reinvested for an extended period of time after asset purchases end, with no end date set.
Interest rates were left unchanged: the interest rates on the main refinancing operations, marginal lending facility, and deposit facility remain at 0%, 0.25%, and -0.4% respectively. Moreover, the ECB kept its forward guidance on interest rates unchanged, reiterating its expectation to keep interest rates at current levels for an extended period of time, and well past the end of asset purchases.
There was little additional information provided in the press conference that followed. ECB President Mario Draghi denied discussing any alternative scenarios other than the announced reduction of asset purchases, and reiterated that this was not a taper, but an adjustment to asset purchases consistent with the feedback rules followed in the past as risks to the inflation outlook evolved.
Financial markets initially interpreted the announcement a bit dovish, sending the euro down about 0.6% vs the U.S. dollar, weakening further after the conclusion of the press conference. Core Euro Area bonds also experienced a small bid this morning, however a small part of the move may be related to news in Spain that the government of Catalonia is planning on calling for elections in order to stall a takeover by Spain’s central government.
Key Implications
The broadening economic recovery in the Euro Area, notable for three consecutive quarters of economic growth at double the trend pace, has given monetary authorities enough confidence in the economic outlook to announce a reduction in asset purchases. This change will come nine months after the monthly pace of asset purchases were reduced to a €60 billion from €80 billion. Moreover, although the pace of asset purchases are set to slow, the size of the ECBs balance sheet will remain at elevated levels for the foreseeable future, and as such maintains the highly accommodative monetary policy supporting the strengthening economic recovery.
As with other advanced economy central banks, the ECB is struggling to explain why wage and price inflation remains so weak despite above trend economic growth and falling unemployment rates. During the press conference, President Draghi explained that the focus remains on monitoring and supporting domestic drivers of wages and prices, mentioning that the ECB cannot affect global forces that may be exerting downward pressure on prices. Overall, the ECB believes that its announced policy changes today remains consistent with a gradual uptick in underlying wage and inflation pressures over the next few years.
