ECB expected to hint at end to easy money at meeting this week

The European Central Bank (ECB).
The European Central Bank (ECB).PHOTO: AFP

FRANKFURT (AFP) - Expectations are high that the European Central Bank will hint that it is heading for the exit from its easy-money policy when governors meet in Estonian capital Tallinn on Thursday.

Most analysts predict the bank's 60-billion-euro (S$93.34 billion) monthly bond purchases will continue and interest rates will remain at historic lows.

But they believe policymakers will begin laying the groundwork for an announcement later this year about plans to wind down bond-buying, by offering a sunnier economic outlook for the 19-nation eurozone.

"The ECB governing council needs to take no major policy decision beyond tweaking its guidance a little to keep up with the eurozone's broad-based and resilient economic recovery," said economist Holger Schmieding of Berenberg bank.

Bond-buying and low interest rates were introduced at a time when the ECB feared the threat of deflation - or steadily decreasing prices the undermine economic activity.

By pumping cash through the financial system and into the real economy, the bank believes it has stimulated growth and pushed inflation back towards its target of just below 2.0 per cent.

Inflation has been on a rollercoaster ride in recent months, hitting the 2.0 per cent target in February before falling back again in March.

The same pattern was repeated with a spike in April, to 1.9 percent, before a retreat in May.

Volatile food and energy prices are to blame for such rapid changes, policymakers say, while "core", or underlying inflation discounting those elements remains sluggish.

ECB president Mario Draghi argues that wages - which he dubs the "linchpin" of price growth - are not rising fast enough to drive inflation, even as the eurozone economy enjoys healthy expansion.

"Deflationary risks might have disappeared, but the ECB is still far away from reaching its inflation objective," said economist Carsten Brzeski of ING Diba bank.

Nevertheless, "the ECB would be blind not to acknowledge the cyclical upswing in the eurozone" in its press conference on Thursday, he added.

In its carefully-weighed policy statements, the central bank has long warned of risks threatening the eurozone recovery.

This in turn has justified language elsewhere in its "forward guidance" suggesting that if economic activity slowed, policymakers could lower interest rates even further or boost bond-buying back to its previous level of 80 billion euros per month.

Observers now expect the ECB to highlight economic risks "balanced" between positive and negative, justifying dropping one or both commitments to signal growing confidence in the economy.

That would not herald a quick exit from bond-buying.

Draghi told European Parliament lawmakers last week he is "firmly convinced" the eurozone's newfound robustness depends on ECB interventions.

The coming months will see policymakers "tiptoeing towards a winding down of asset purchases in 2018," Berenberg's Schmieding said, with an interest rate hike far over the horizon.

New economic forecasts next week from the ECB's staff are expected to show lower inflation expectations than previously, lending support to governing council members who want to stay the course.

The ECB is keen to avoid financial market upsets as it heads for the exit from its bond-buying programme.

Removing its demand for government bonds from the market could drive up yields, the returns investors can expect when buying government debt, for the eurozone's weaker economies.

But it is also under pressure to end the scheme, as some governing council members believe it is no longer justified without deflation risks.

Meanwhile, pressure from politicians in fiscally conservative countries like Germany is mounting over low inflation's impact on savers.

German Finance Minister Wolfgang Schaeuble has also blamed the ECB for trade tensions with the United States, charging that the bank's policy makes German exports too cheap.

And technical considerations could soon limit the number of government bonds available for the ECB to buy, cramping the programme's effectiveness.

Even given those constraints, "the ECB does not seem to be in any rush," ING's Brzeski said.

Central bankers "will do everything possible to avoid" spooking markets by announcing any changes gradually between next week and the end of the year, he predicted.