ECB's Draghi Hints At Possible Winding Down of Eurozone QE -- 4th Update

By Tom Fairless Features Dow Jones Newswires

SINTRA, Portugal--European Central Bank President Mario Draghi hinted on Tuesday that the ECB might start winding down its large monetary stimulus as the eurozone economy picks up speed, even as he warned against an abrupt end to years of easy money.

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The comments, at the ECB's annual economic-policy conference in Portugal, come as investors watch closely for a sign that the world's second most powerful central bank is preparing to withdraw controversial policies such as its EUR60 billion ($67.52 billion) a month bond-buying program.

Investors took them as a signal that the ECB is moving toward that goal. The euro leaped 0.9% against the dollar to $1.1284, while eurozone government bond yields also rose sharply.

So far, top ECB officials have avoided discussing the future of their bond purchases after December, when the program is currently set to end.

Mr. Draghi said the ECB's stimulus policies are working and will be slowly withdrawn as the economy accelerates. However, he warned that "any adjustments to our stance have to be made gradually, and only when the improving dynamics that justify them appear sufficiently secure."

"Today Draghi moved his first step towards indicating that ECB monetary policy will become less [stimulative] in 2018," said Marco Valli, an economist with UniCredit in Milan.

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Most analysts expect the central bank to announce in September or October that it will start early next year to taper, or wind down, its bond purchases, known as quantitative easing.

Mr. Draghi didn't directly address the question of timing. He highlighted positive developments in the eurozone economy, including broadening economic growth and reduced political uncertainty. Emmanuel Macron's victory in France's presidential elections last month helped stem concerns that his far-right rival, Marine Le Pen, might drastically alter the shape of the eurozone.

"Political winds are becoming tailwinds," Mr. Draghi said. "There is newfound confidence in the reform process, and newfound support for European cohesion, which could help unleash pent-up demand and investment."

At a policy meeting earlier this month, the ECB took a tiny step toward ending its stimulus, signaling it probably wouldn't cut interest rates any further below zero. But Mr. Draghi said after the meeting that policy makers hadn't even discussed unwinding their stimulus.

On Tuesday, the ECB chief indicated that any change would have to be gradual, "to ensure that our stimulus accompanies the recovery amid the lingering uncertainties."

That tone of continued caution may disappoint officials in Northern Europe, who have been calling for a swift exit from stimulus as economic growth and inflation recover. Top officials in Germany, Europe's largest economy, have for years called for an end to policies that they complain hurt savers and pensioners.

The dilemma for ECB officials is that while eurozone growth is accelerating, outpacing the U.S. in the first quarter, the bloc's inflation rate remains weak. It slid to 1.4% in May, some way below the ECB's target of just below 2%.

Mr. Draghi suggested that inflation has fallen short due to temporary factors that the ECB can afford to ignore. They include falling energy and commodity prices, and changes to the labor force that reduce workers' power to demand higher wages, he said.

Mr. Valli said the ECB might reduce its monthly bond purchases to EUR40 billion in the first half of next year, followed by a further reduction to EUR20 billion a month in the second half of the year. That would be a slower pace of stimulus reduction than many analysts had been expecting.

However, the ECB is expected to face a serious challenge if it wants to extend QE much beyond the middle of next year. The central bank is soon expected to start running short of bonds to buy, particularly in Germany, due to self-imposed constraints in the design of QE.

Write to Tom Fairless at tom.fairless@wsj.com

(END) Dow Jones Newswires

June 27, 2017 10:45 ET (14:45 GMT)