ECB's Draghi Hints at Possible Winding Down of Eurozone QE -- 5th Update

By Tom Fairless Features Dow Jones Newswires

SINTRA, Portugal -- The euro climbed against the dollar and eurozone bond prices slumped Tuesday after European Central Bank President Mario Draghi hinted the ECB might start winding down its monetary stimulus in response to an accelerating eurozone economy.

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A move toward reducing stimulus by the ECB would put the world's two most powerful central banks back on a similar policy path for the first time in four years, as the U.S. Federal Reserve first signaled a similar move in 2013 and has been raising interest rates gradually since December 2015.

Mr. Draghi's comments, at the ECB's annual economic policy conference in Portugal, were laced with caution and caveats. But investors interpreted them as a signal that the ECB was moving toward exiting its quantitative-easing program, in which it buys EUR60 billion ($67.15 billion) a month in bonds.

The EUR2.3 trillion program has had a large impact on financial markets. After Mr. Draghi spoke Tuesday, the euro rose more than 1.4% against the dollar to $1.1346, and eurozone government bond yields also rose sharply. Bond yields rise as prices fall.

Pressure has been mounting on the ECB to change course as evidence accumulates that its aggressive stimulus is bearing fruit, and as political uncertainty in the region fades following Emmanuel Macron's election as French president.

The eurozone has notched 16 straight quarters of economic growth, creating more than six million jobs, and business and consumer confidence have risen to multiyear highs.

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So far, though, the ECB's top officials have carefully avoided discussing the future of their QE program, which is due to continue through December. They worry that such a discussion could lead to sudden moves in financial markets that might upset the region's economic recovery.

On Tuesday, Mr. Draghi appeared to shift course. He argued that leaving the ECB's policy unchanged as the euro area's recovery strengthened would amount to increasing its stimulus -- a hint that policy makers will instead start to reduce their bond purchases.

"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.

The change comes as the Federal Reserve indicates it will continue to raise interest rates over the coming years. Fed officials indicated earlier this month they are on course to raise borrowing costs once more in 2017, after increasing the bank's benchmark rate twice this year to a range between 1% and 1.25%. The U.S. central bank also plans to begin reducing the amount of bonds it holds.

Earlier this month, the ECB took a tiny step toward ending its stimulus by signaling it probably wouldn't cut interest rates any further below zero. Many analysts expect the central bank to announce in September or October that it will start early next year to taper, or wind down, its QE program.

Mr. Draghi didn't directly address the question of timing. He highlighted positive developments in the eurozone, including broadening economic growth and reduced political uncertainty.

"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."

Michael Schubert, an economist at Commerzbank in Frankfurt, said the latest remarks were "another sign suggesting that the central bank is moving towards an exit from its" stimulus.

Still, the ECB chief stressed that any exit from stimulus would "have to be made gradually," and only when the path of growth and inflation was "sufficiently secure."

Some analysts called for caution.

"We don't think we should be surprised by" Mr. Draghi's comments, economists at Bank of America Merrill Lynch wrote in a research note. "What he said today is also consistent with a very slow exit."

If so, that would disappoint officials in Northern Europe, who have been pressing for a swift end to the ECB's monetary stimulus. In Germany, Europe's largest economy, top officials have called for years for an end to policies 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 area's inflation rate remains weak. It slid to 1.4% in May, some way below the ECB's target of just under 2%.

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 expect.

However, the ECB is expected to face a 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 17:02 ET (21:02 GMT)