The European Central Bank said Thursday that it will scale down its giant bond-buying program while extending it deep into 2018, in a keenly awaited move that sets the eurozone on a path toward higher interest rates as its long economic crisis recedes.
The move is an acknowledgment that with growth having proved surprisingly strong this year, the eurozone economy needs less support from central bankers.
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But it is also an attempt to ensure the recovery isn't slowed by a sharp rise in borrowing costs, and ECB President Mario Draghi said the continued stimulus is needed if inflation is to rise to its 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.
In a policy statement, the ECB said it would continue to buy bonds through September 2018, but that the pace of its purchases would fall to EUR30 billion ($35 billion) a month from EUR60 billion after December this year. The bank also left its key interest rates unchanged.
The Euro Stoxx 50 index of eurozone stocks doubled the morning's gains after the announcement, rising 0.6%. The euro edged down 0.5% to $1.1754 from $1.1807 while yields on German 10-year bonds edged down to 0.445% 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.
The decision reflects concerns that inflation--the ECB's primary focus--remains too weak, although Mr. Draghi said policy makers have "growing confidence in the convergence of inflation to our aim."
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.
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.
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.
Paul Hannon contributed to this article.
Write to Tom Fairless at email@example.com
(END) Dow Jones Newswires
October 26, 2017 09:11 ET (13:11 GMT)