ECB Weighs Ending Stimulus as Fed Calibrates Its Easy Money Stance -- 7th Update

By Tom Fairless in Frankfurt and Nick Timiraos in Washington Features Dow Jones Newswires

The European Central Bank is likely to announce plans next month for phasing out the bond-buying program that has helped reinvigorate the eurozone economy, while the U.S. Federal Reserve is weighing how aggressively to retreat from its own easy money policies.

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ECB President Margio Draghi signaled Thursday the bank could next month announce a plan to gradually end a program of asset purchases, known as quantitative easing or QE, in 2018. The Fed has already ended its bond purchases and is poised to announce plans in two weeks to begin reducing the $4.5-trillion portfolio of securities it accumulated during and after the 2007-2009 financial crisis. But U.S. officials are becoming hesitant about raising short-term interest rates for a third time this year, as they had anticipated doing a few months ago.

A wild card for both central banks is inflation, which has remained stubbornly low despite steady hiring and a pickup in global economic growth. Officials on both continents aren't sure whether those trends are caused by short-term factors that will fade soon, or by deeper long-term changes in the fabric of the economy. If longer-term forces are holding down inflation, the central banks can afford to be patient about pulling away from low-interest-rate and bond-purchase policies.

The Fed is much farther along than the ECB in unwinding its stimulus programs. The Fed stopped purchasing bonds in 2014 and started raising short-term interest rates in late 2015. The ECB is only now considering an end to its bond purchases and is nowhere near considering reducing its holdings or raising its interest rates from zero and below. The ECB also faces an additional risk: Ending its bond program could further push up the euro, crimping exports, pressing down on inflation and cutting off the growth it has been trying to stimulate.

Investors are on edge, waiting for a clear plan from the major central banks on how quickly the era of easy money will draw to a close. The hypersensitivity of financial markets is making central bankers nervous and could delay their exit plans.

At a news conference on Thursday, Mr. Draghi said policy makers this week discussed options for reducing stimulus and would likely decide at their next meeting on Oct. 26 how to "calibrate" bond purchases next year. He pointed to strengthening growth across the 19-nation eurozone and early signs of an uptick in underlying inflation.

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"We are studying what to do next year," Mr. Draghi said. "Judging by the way the work is going, we should be ready" by late October.

But he also warned that the bank's next steps would depend partly on the strength of the euro, which has surged by more than 12% against the dollar over the past five months.

The euro seesawed during Mr. Draghi's remarks, jumping almost a cent to $1.2047 after the ECB chief unveiled higher economic growth forecasts, but later fell back to around $1.20. Yields on German government bonds slid lower.

"As long as the ECB is prepared to talk but not act on the exchange rate, there's little standing in the way of further euro appreciation," said Lena Komileva, an economist with G+ Economics in London.

Mr. Draghi gave few clues about the bank's exit plan, stressing that discussions had been "very, very preliminary" and that policy makers would await further analysis from ECB staff before deciding.

Pressure is building on the ECB to shift course. In Germany, Europe's largest economy, the bank's policies have been a hot topic in the campaign for national elections on Sept 24. Earlier this week German Finance Minister Wolfgang Schäuble called for more "normal" monetary policy, pointing to the strong economic recovery.

Deutsche Bank chief executive John Cryan made a similar plea on Wednesday. The bank's stock was down more than 1% on Thursday after Mr. Draghi indicated that a key ECB interest rate would remain below zero for some time, regardless of the plans for QE. Negative rates tend to weigh on bank profits.

Like policy makers in Japan and the U.S., officials in Frankfurt are concerned that the economic recovery hasn't been accompanied by stronger inflation.

Several Fed officials have indicated in recent interviews and public comments they are poised to announce at their Sept. 19-20 meeting that they will start slowly shrinking the central bank's asset holdings while leaving rates unchanged.

The bigger question about the meeting is how many officials will again project one more interest rate increase this year, as a large majority did in June, and what Fed Chairwoman Janet Yellen will publicly say on the matter in light of an inflation soft patch that has lasted longer than officials expected.

With the unemployment rate falling to the low range of officials' projections, most expect inflation should eventually rise to the Fed's 2% target. But because inflation has remained weak for several months and short-term interest rates have moved closer this year to their long-run level, some officials have said they want to see more evidence of a pickup in prices before moving rates up again.

In June, Ms. Yellen said inflation appeared to be soft due to transitory factors, including one-off price declines for a handful of items such as wireless phone plans and prescription drugs. In July, she said that was still her expectation but qualified her statement with a nod to the inherent uncertainty.

"It's premature to conclude that the underlying inflation trend is falling well short of 2%," Ms. Yellen told lawmakers. She added, "Policy is not something that's set in stone, and if our evaluation changes with respect to inflation, that will make a difference."

Several U.S. officials have said they believe tight labor markets are now forcing employers to compete for workers, a trend that should lead to rising wages and prices and justify another rate increase later this year.

Still, if inflation doesn't soon show signs of an upturn and the unemployment rate doesn't fall much further from its recent low of 4.3%, Fed officials could decide to forego another rate move this year.

ECB officials are puzzling over the same problem. Mr. Draghi argued recently that inflation is probably being held down by temporary factors, including recent declines in energy and commodity prices, a large pool of underemployed workers, and negative feedback from a long period of low inflation.

A central bank can typically look past such factors, Mr. Draghi said. Still, coupled with a stronger euro, they have made the ECB cautious about withdrawing its stimulus too soon.

Write to Tom Fairless at tom.fairless@wsj.com and Nick Timiraos at nick.timiraos@wsj.com

(END) Dow Jones Newswires

September 07, 2017 18:09 ET (22:09 GMT)