ECB to Scale Down but Extend Bond-Buying Program -- 6th Update

By Paul Hannon and Tom Fairless Features Dow Jones Newswires

European Central Bank President Mario Draghi said the bank's giant bond-buying program could be extended beyond September 2018, having earlier added another nine months to its life-span.

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The commitment to keep the program open-ended underlines the ECB's caution as it attempts to wean the crisis-scarred eurozone economy off its stimulus without harming a recently strengthened recovery.

"The decision today is for an open-ended program, it's not going to stop suddenly," Mr. Draghi said in a news conference. "It's never been our view that it should stop suddenly."

The move to extend the bond-buying program through September, while cutting purchases to EUR30 billion ($35 billion) a month from EUR60 billion after December this year, is an acknowledgment that the eurozone economy needs less support from central bankers.

But it is also an attempt to ensure the recovery isn't slowed by a sharp rise in borrowing costs, and Mr. Draghi said the continued stimulus is needed if inflation is to rise to the ECB's target of just under 2%.

"Domestic price pressures are still muted overall and the economic outlook and the path of inflation are conditional on continued support from monetary policy," he said in a news conference.

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The Euro Stoxx 50 index of eurozone stocks doubled the morning's gains after the announcement, rising 0.6%. The euro edged down 0.8% to $1.1719 from $1.1807 while yields on German 10-year bonds edged down to 0.442% from 0.464% just ahead of the news. Yields move inversely to prices.

"It's the most consensus result that you could've expected," said James Athey, investment manager at Aberdeen Standard Investments.

Mr. Draghi welcomed what he said was a "muted" response to the announcements as a sign that "our communication to the market has been pretty effective."

It is the third time that the ECB has extended its calendar for bond purchases, known as quantitative easing, or QE. The latest move will push the overall size of the program above EUR2.5 trillion, or almost a quarter of the region's economic output, and more than double its originally planned size.

While the decision to extend QE was widely expected, the ECB threw in some sweeteners, including a promise to reinvest the proceeds of maturing bonds for "an extended period of time," and to lend freely to banks against collateral at least until the end of 2019. Mr. Draghi underlined the importance of the commitment to reinvest, and while declining to give an estimate of the amounts involved said they were "going to be massive."

The bank also left open the option to extend QE again, rather than announcing a fixed end-date. That decision gives the central bank flexibility to respond to future economic shocks, ahead of national elections in Italy and a possible change of leadership at the Federal Reserve. But it is likely to upset some ECB officials, who were eager to draw a line under QE.

The decision to scale down QE sets the ECB on the same policy path as the Fed, which started raising interest rates almost two years ago and is expected to announce another increase in December, its third this year.

Still, the ECB said it is some way from raising rates. It expects interest rates to remain at their current levels "well past" the end of QE, according to its policy statement. Most investors don't expect an ECB rate increase until spring 2019.

That should help to check any rise in eurozone bond yields or the euro currency. The euro has risen by around 12% against the dollar this year but has held steady since September, when ECB officials raised concerns about its strength. The euro remains weak by historical standards, helping to support the region's large exporters and contributing to record current-account surpluses.

The ECB's decision leaves little room for error. After the latest extension, the ECB will have exhausted the bonds that it is allowed to purchase under the current rules of QE. That raises questions about the ECB's ability to respond to any future crisis--notwithstanding the bank's stated willingness to scale up the program again if necessary.

However, Mr. Draghi said the existing program had the flexibility needed for a further extension, and added that policy makers hadn't discussed any change to the self-imposed rules governing the program.

"We gave plenty of evidence that our design is flexible enough to cope with the potential limits," he said.

Despite the ECB's caution, investors worry that higher borrowing costs could put pressure on the region's highly indebted households, private firms and governments, many of which have made little progress in paying down the debts accumulated during the recent financial crisis.

On the other hand, the extension of QE is likely to deepen concerns, particularly in Germany, about the harmful side effects of years of easy money. They include potential asset-price bubbles, lower returns for savers, and the misallocation of resources to nonviable "zombie" firms. Critics contend that such adverse side effects accumulate over time, even as the positive impact of QE diminishes.

Mr. Draghi said that while there had been a "broad consensus" on the size of the program going into 2018, some of the 25-member governing council had argued for setting a definite end to purchases.

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

FRANKFURT -- The European Central Bank said Thursday it would carry on buying government bonds deep into next year but in reduced monthly amounts, a milestone policy shift that signals it will follow the U.S. Federal Reserve on a path toward higher interest rates.

The decision marks the beginning of the end of a policy tool the ECB adopted to stave off deflation: large-scale purchases of eurozone government bonds, known as quantitative easing, or QE.

Europe's strengthening economic recovery is reducing the need for such a stimulus in the ECB's eyes, even though inflation remains weak and well below the bank's target.

The ECB signaled it is moving away from easy money, but the message was laden with caveats, and the bank left open exactly when, and how, its stimulus measures would end.

The decision to reduce QE gently comes amid a rare, synchronized recovery across the world's major economies, a result of extraordinary efforts by central banks to support growth and the fading, at last, of the financial-crisis era.

The ECB's decision reopened a rift within the bank's governing council, where Germany's central bank, the Bundesbank, has led a minority faction that wanted a more decisive end to stimulus but was outvoted.

Under the plan, the ECB will continue to buy bonds through September 2018, but cut the pace of its purchases to EUR30 billion ($35.4 billion) a month from EUR60 billion after December this year. The bank also left its key interest rates unchanged and said that rate rises remain some way off.

Europe's exit from QE will thus be far slower than that pursued four years ago by the Fed, which cut its purchases by $10 billion a month.

ECB President Mario Draghi told a news conference that the decision didn't signal the end of QE, which economists credit with supporting the region's strong economic recovery. Instead, he indicated QE would probably be extended again, beyond September 2018, an unexpected sweetener for investors.

"This is not tapering, it's a downsize," Mr. Draghi said. The word "tapering," shorthand for winding down QE to zero, wasn't mentioned in the ECB's policy discussions this week, he said.

It is the third time that the ECB has extended its calendar for QE. The latest move will push the overall size of the program above EUR2.5 trillion, or almost a quarter of the region's economic output, and more than double its originally planned size.

Investors welcomed Mr. Draghi's balancing act, which pushed back market expectations for an ECB interest-rate increase deep into 2019.

"This is softly, softly tapering," said Ian Stewart, chief economist at Deloitte. "The ECB certainly isn't taking away the punch bowl."

The euro fell 1% against the dollar Thursday, on track for its biggest daily decline since August, while shares of companies in the eurozone's most indebted nations jumped on a bet that the ECB's extraordinary monetary stimulus would support the region's markets for longer than many had anticipated.

The ECB also promised to reinvest the proceeds of maturing bonds for "an extended period of time," and to lend freely to banks against collateral until at least the end of 2019. Mr. Draghi underlined the importance of the commitment to reinvest, and while declining to give an estimate of the amounts involved, said they were "going to be massive."

Those comments helped to avoid a financial-market turbulence, which investors had feared could follow from a strong signal that tighter monetary policy was approaching.

But the decision drew dissent on the ECB's 25-member rate-setting committee. Bundesbank President Jens Weidmann opposed it, worried that the ECB hadn't yet drawn the curtain on QE despite the eurozone's robust economic recovery, according to a person familiar with his thinking.

Mr. Weidmann is a longtime critic of the ECB's bond purchases, and has been arguing for a quicker withdrawal of monetary stimulus.

Mr. Weidmann would have been willing to support a fresh extension of quantitative easing if the program's end had been more clearly in sight, the person said. Some other members also had reservations about keeping QE open-ended, ECB officials said.

Mr. Draghi spoke glowingly of the eurozone's economic recovery, but argued it was heavily reliant on "ample" support from the central bank. "We must be patient and persistent," he said.

The commitment to keep the QE program open-ended gives the ECB flexibility to respond to future economic turbulence, ahead of national elections in Italy and a possible change of leadership at the Fed.

But it leaves little room for error. By September, the ECB will have almost exhausted the bonds that it is allowed to purchase under the current rules of QE, which limit the bank to buying only 33% of any individual government's debt. That raises questions about the ECB's ability to respond to any future crisis -- despite the bank's stated willingness to scale up the program again if necessary.

Mr. Draghi declined to address concerns about possible bond shortages on Thursday. He said policy makers hadn't discussed any change to the self-imposed rules governing QE, but insisted they would be able to find enough bonds if needed.

Some ECB officials doubt the credibility of that pledge, including Mr. Weidmann, according to a person familiar with the matter.

Despite the ECB's caution, investors worry that higher borrowing costs could put pressure on the region's highly indebted households, private firms and governments, many of which have made little progress in paying down the debts accumulated during the recent financial crisis.

On the other hand, the extension of QE is likely to deepen concerns, particularly in Germany, about the harmful side effects of years of easy money. They include potential asset-price bubbles, lower returns for savers, and the misallocation of resources to so-called zombie firms, which are highly-indebted firms kept alive by low interest rates but that are unable to afford to pay down their debts.

Critics contend that such adverse side effects accumulate over time, even as the positive impact of QE diminishes.

--Riva Gold and Paul Hannon in London contributed to this article.

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

(END) Dow Jones Newswires

October 26, 2017 16:52 ET (20:52 GMT)