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ECB to end bond buys, keep rates steady through next summer

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The European Central Bank said on Thursday it will end its unprecedented bond purchase scheme by the close of the year, taking its biggest step in dismantling crisis-era stimulus a decade after the start of the euro zone's economic downturn.

[FRANKFURT] The European Central Bank said on Thursday it will end its unprecedented bond purchase scheme by the close of the year, taking its biggest step in dismantling crisis-era stimulus a decade after the start of the euro zone's economic downturn.

Signalling that the move would not mean rapid policy tightening in the coming months, the bank also said that interest rates would stay at record lows at least through the summer of 2019, suggesting protracted support for the economy, even if at a lower level.

ECB President Mario Draghi said the euro-area economy is strong enough to overcome increased risk, justifying the bank’s decision to halt bond purchases and end an extraordinary chapter in the decade-long struggle with financial crises and recession.

“We’ve taken these decisions knowing that the economy is in a better situation, with an increase in uncertainty,” Mr Draghi said at a briefing in Riga, where the Frankfurt-based ECB held its annual out-of-town meeting. “We may well have this soft patch being somewhat longer than in the staff projections in some countries.”

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Markets had been pricing in a 10 basis point hike in the ECB's benchmark deposit rate - currently at -0.4 per cent - by June 2019.

Though full policy normalisation will take years, investors are braced for the end of easy money from the world's top central banks. A hawkish US Federal Reserve dropped a crisis-era stimulus pledge on Wednesday while the ECB had already begun rolling back support after a five-year run of economic growth.

"The monthly pace of the net asset purchases will be reduced to 15 billion euros(S$23.6 billion) until the end of December 2018 and ... net purchases will then end," the ECB said in a statement after policymakers met in the Latvian capital Riga.

The decision affirms market expectations for the bond purchases to conclude by year-end after a short period of tapering, and indicates that interest rates will once again become the bank's primary policy tool.

"The Governing Council expects the key ECB interest rates to remain at their present levels at least through the summer of 2019, and in any case for as long as necessary to ensure that the evolution of inflation remains aligned with the current expectations of a sustained adjustment path," the ECB said.

The biggest complication for the process of normalisation could be a murky economic outlook, muddied by a developing trade war with the United States, a populist challenge from Italy's new government and softening export demand.

But ECB policymakers have long argued that their mandate is to bring inflation back to target, not to prop up growth or fight off market turbulence in any particular country.

Italian bond yields rose sharply this month as a new government of anti-establishment parties promised higher spending. That threatens a clash with Brussels, which is pushing Rome to cut the euro zone's second-biggest debt pile.

A broader slowdown could make it harder for the ECB to cut support if lower growth eases pressure on inflation, a threat to the bank's credibility as it has missed its inflation target of almost 2 per cent for over five years.

While inflation has remained weak, higher oil prices, increasingly evident wage pressures and record employment suggest that prices will be moving up in the coming years, even if more slowly than the ECB had originally hoped.

ECB Chief Economist Peter Praet, a Draghi ally and one of the most dovish members of the rate-setting Governing Council, recently argued that progress has been made on the inflation criteria, a strong hint that stimulus would be pared back.

The euro's 5 per cent fall against the dollar since April is also helping the ECB as the weaker currency is increasing the cost of imports and boosting inflation. While a rebound is likely, the US Fed's tightening stance will limit the potential for a big rise in the euro.

REUTERS,BLOOMBERG