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.
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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.
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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 from 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 nonviable, so-called zombie firms. 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 firstname.lastname@example.org
(END) Dow Jones Newswires
October 26, 2017 16:46 ET (20:46 GMT)