Mario Draghi Says ECB Held Talks on Future of Stimulus -- 5th Update

By Tom Fairless and Paul Hannon Features Dow Jones Newswires

The European Central Bank is likely to announce plans for phasing out its bond-buying program next month, bank President Mario Draghi signaled Thursday, taking a tentative step toward withdrawing a controversial stimulus tool that has helped reinvigorate the eurozone economy but also sparked fierce opposition in its largest member, Germany.

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At a news conference, 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, amid strengthening growth across the 19-nation eurozone and early signs of an uptick in underlying inflation.

Any move to wind down the purchases, known as quantitative easing or QE, would put the world's two most powerful central banks back on a similar policy course. The Federal Reserve has been gradually raising interest rates since late 2015 and could signal later this month how it plans to start reducing its balance sheet.

But in a sign that the ECB's path out of stimulus might be as hesitant as the route in, Mr. Draghi 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.

A strong currency complicates the ECB's exit from QE because it makes eurozone exports less competitive and weighs on import prices and thus inflation. That impact was evident in the ECB's new economic forecasts, which reduced expected inflation for the coming two years.

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Investors had expected Mr. Draghi to try to verbally check the euro's rise, but his remarks didn't prevent traders from pushing the currency higher.

"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.

The ECB is wrestling with a tricky combination of stronger economic growth, a rising currency and weak inflation. Eurozone inflation was 1.5% last month, some way from the ECB's target of just below 2%.

Senior German officials have been calling with increasing urgency for a policy reversal from Frankfurt, warning that ultralow rates hurt the nation's conservative savers and pensioners. The issue has 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.

Investors are on edge, waiting for a clear plan from the ECB on the future of QE after December, when the EUR60 billion-a-month program is currently due to end. Since its launch 2 1/2 years ago, the program has helped keep down borrowing costs and the euro's exchange rate, fueling a robust recovery across the eurozone.

ECB officials have indicated in recent months that QE will probably be phased out by mid-2018, but that economic developments could change the timetable.

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

The ECB remains "on track to taper its asset purchases from the start of next year, although we may have to wait until the October meeting -- or maybe longer -- to see the details," Adrian Hilton, head of global rates and currency at Columbia Threadneedle Investments in London, said in a research note. "Were the euro to push on towards the 1.25 level versus the dollar, however, the bank may find itself trapped between a disinflationary exchange rate and a need to phase out its QE purchases before it runs out of bonds to buy," he said.

Mr. Draghi painted a rosy picture of the region's economy, unveiling stronger growth forecasts for 2017, and pointing to early signs of an uptick in underlying inflation. Core inflation -- a measure that eliminates volatile components such as food and energy -- was 1.2% in August, compared with 0.8% a year earlier.

The ECB now expects the currency area's gross domestic product to rise 2.2% this year. That would be the eurozone's fastest expansion since 2007, before the global financial crisis.

"A crisis-era [stimulus] program geared for recession, with negative rates and aggressive bond purchases, looks a little long in the tooth," Ms. Komileva said of the ECB's current policy mix.

Financial markets took fright in late June when Mr. Draghi hinted in Sintra, Portugal, that the ECB might gradually start to shrink its stimulus as the region's economy strengthens. Since then the ECB had offered no fresh guidance on its next steps.

Like policy makers in Japan and the U.S., officials in Frankfurt are scratching their heads as to why the economic recovery hasn't been accompanied by stronger inflation.

The Fed is also cautious. The U.S. central bank has been gradually raising interest rates since late 2015, but top Fed officials have warned recently that it may be difficult to continue because of persistently weak inflation.

Adding to the pressure, Hurricane Irma is threatening the U.S. coastline and the U.S. is facing a potential confrontation with North Korea over nuclear tests.

Given the wariness among policy makers, many investors are positioning for another year of QE, according to Ms. Komileva.

Write to Tom Fairless at tom.fairless@wsj.com and Paul Hannon at paul.hannon@wsj.com

(END) Dow Jones Newswires

September 07, 2017 14:12 ET (18:12 GMT)