ECB to begin phase out of stimulus program

By David Mchugh, The Associated Press | June 14, 2018 | Last updated on June 14, 2018
3 min read

The European Central Bank has decided to phase out the bond-buying stimulus program credited with helping the 19 countries that use the euro recover from the Great Recession and eurozone debt crisis.

The bank said Thursday that the stimulus program’s bond purchases would be reduced to 15 billion euros (US$17.7 billion) a month, from the current 30 billion euros, beginning in October. They would then be wound up completely after December.

The bank was careful to underline that it would withdraw the support for the economy only gradually, saying its key interest rates would not rise from record lows until at least the summer of 2019, and could stay low for longer if needed.

“The ECB’s announcement that it will end its asset purchases in December is probably a little bolder than markets had expected, but this is tempered by the pledge to keep interest rates on hold for more than a year,” said Jennifer McKeown, chief European economist at Capital Economics.

The bank’s move toward the exit comes a day after the U.S. Federal Reserve decided to make its second interest rate increase this year and indicated more were coming. The central banks are withdrawing stimulus efforts that started during the Great Recession as their economies strengthen. ECB President Mario Draghi says the bank’s policy of easy money has helped create millions of new jobs, with unemployment falling from over 12% during the crisis to 8.5%.

Read: Fed raises key rate, signals 4 rate hikes this year

The eurozone was also hit with a crisis over high debt in Greece, Italy, Portugal, Ireland, Spain and Cyprus, followed by a period of worryingly low inflation that suggested the economy remained weak.

People are paying attention to the bond purchase exit because it will have wide-ranging effects in markets and the economy. The purchases, which pump newly created money into the financial system, have driven down longer-term interest rates for borrowers, such as governments and home buyers, but have reduced returns for savers and made it harder to fund pension savings due to low returns on safe investments.

The stimulus has also pushed up the prices of investments likes stocks and bonds. As the stimulus is ended and then withdrawn by letting the bond holdings run down over a period of years, those effects will go into reverse. More conservative investments will become relatively more attractive.

The euro fell sharply after Thursday’s decision, from $1.1820 to $1.1635, suggesting investors think rates won’t rise soon.

Thurday’s decision indicates the ECB is relatively confident about the recovery despite slower growth recently. It was also not deterred by questions about the new, populist government in Italy. The coalition between the anti-establishment 5-Star Movement and the anti-immigration League has promised spending that could lead to Italy violating eurozone limits on deficits. At various times the parties have also questioned Italy’s membership in the euro itself. The country’s finance minister has, however, helped calm markets by saying recently that his country has no intention to leave.

Read: EU predicts solid growth this year and next

Draghi dismissed any attempts by populist politicians to question the euro.

“It doesn’t pay at all to discuss the existence of something that’s irreversible. It can only create damages,” he told a news conference.

The ECB trimmed its growth forecast for this year but raised inflation prediction to 1.7% for this year, 2019 and 2020. It previously expected inflation of 1.4% this year and next.

The ECB’s mission is to keep prices growing at a steady and modest pace of just under 2% annually. It enacted stimulus as the region was afflicted with an extended period of very low inflation.

Inflation has recovered—to 1.9% in May—but the bank wants to be able to show it will remain around there even after the stimulus has been stopped.

The bank kept its short-term interest rate benchmark at a record low of zero and its rate on deposits from commercial banks stayed at minus 0.4%. That is a penalty aimed at pushing banks to lend the money instead of leaving it at the central bank.

Read: ECB leaves rates unchanged despite strong 2017 growth

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David Mchugh, The Associated Press

David Mchugh is a reporter with The Associated Press, an American not-for-profit news agency headquartered in New York City and founded in 1846.