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Draghi to reassure markets as ECB plots exit course

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European Central Bank President Mario Draghi will seek to soothe financial markets at a policy-setting meeting on Thursday, analysts predicted, while at the same time carefully preparing the ground for an eventual shift away from easy-money policy later this year.

[FRANKFURT] European Central Bank President Mario Draghi will seek to soothe financial markets at a policy-setting meeting on Thursday, analysts predicted, while at the same time carefully preparing the ground for an eventual shift away from easy-money policy later this year.

Most observers expect the Frankfurt-based institution to chart a path to the exit from its "quantitative easing" (QE) mass bond-buying programme at one of its four remaining meetings in 2017.

That will make a press conference on Thursday "a balancing act that requires all of Mr Draghi's verbal acrobatic skills," said analyst Carsten Brzeski of ING Diba bank, as the ECB must prime the markets for an end to QE, but also be careful not to sow panic.

Along with historic low interest rates and cheap loans to banks, the ECB's monthly purchases of 60 billion euros (S$95 billion) of government and corporate bonds are designed to pump cash into the economy, powering growth and pushing up prices.

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While inflation is still sluggish, economic growth in the 19-nation eurozone has picked up strongly enough to dispel the fears of deflation that had prompted policymakers to launch the scheme.

And the ECB could soon reach technical limits to its bond-buying that will make the already controversial programme even more difficult to continue much beyond the present cut-off point in December.

IN THE SPOTLIGHT

Such signs mean investors are on high alert for signals from the central bank, sensitive to even the tiniest changes in governors' carefully-weighed statements on "forward guidance".

At a meeting in June, policymakers chose to remove a suggestion that interest rates could be lowered still further if necessary from their regular statement.

That was seen by many as the first hint that the ECB would begin adjusting its policy as economic growth gathers pace.

Speculation was ratcheted up still further when Mr Draghi told a central banking conference late last month that "as the economy continues to recover... the central bank can accompany the recovery by adjusting the parameters of its policy instruments".

This was interpreted by markets as a gesture towards "tapering", or winding down bond-buying. And the remarks pushed up bond yields - the returns investors can expect from buying government debt - and the value of the euro.

If those trends continue, they could sap growth in the single currency area. So, the ECB hastily sought to clarify Mr Draghi's words.

"The reaction of bond markets over the last two weeks was a good reminder of how thin the line is between preparing markets and distorting them," analyst Brzeski pointed out.

Despite the risks, the ECB "will probably be prepared to accept a moderate financial market impact now in order to avoid much sharper moves when the time to taper finally comes," economist Jennifer McKeown of Capital Economics said.

That could see Mr Draghi renewing his optimistic assessment of eurozone prospects on Thursday, but refraining from more concrete changes for the moment, she argued.

Plans to end QE will require careful justification, as the ECB's own inflation forecasts - of 1.5 per cent this year and 1.3 per cent in 2018 - remain well short of its target of just below 2.0 per cent.

LOW RATE MARATHON

Any observers looking for interest rates to rise from their historic lows likely have a long wait ahead, analysts agree.

The ECB has for many months stated that rates will only start to rise "well after the horizon of net asset purchases" has come to an end.

The bond-buying programme itself might not be completely wound down until far into 2018, while low inflation expectations stretching into 2019 would make it difficult to justify higher rates.

"If anything, the ECB will signal more strongly in the coming months that it does not envisage raising rates in the foreseeable future," Capital Economics' McKeown said.

Other central banks have left "at least six months" between ending QE schemes and raising rates, she noted - a pattern that suggests a eurozone hike is extremely unlikely in 2018.

AFP

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