ECB slows asset purchases as Draghi heads for stimulus exit

(Bloomberg) The European Central Bank will reduce its monthly bond purchases next year in a step toward ending a programme that has spent more than €2 trillion trying to revive euro-area inflation.

Policy makers agreed to scale back buying to €30 billion a month starting in January and continue for nine months until the end of September, a decision that was in line with economists' estimates. That'll take its total holdings to at least €2.55 trillion.

Still, the central bank also emphasised that it'll move extremely cautiously. It kept its pledge to step up or extend buying further if needed, changed the language on its reinvestment strategy for maturing debt, and reiterated that banks will be able to borrow as much as they need in refinancing operations.

The decision marks a watershed moment for Mario Draghi, who heads into the final two years of his ECB presidency after a tenure spent easing policy to contain the fallout from the region's debt crisis and stave off deflation. The 19-nation bloc is on track for its fastest expansion in a decade, and the central bank is betting that inflation is finally on the verge of picking up.  

The Governing Council reiterated that it will continue to spend €60 billion a month on debt until the end of December. Officials kept the main refinancing rate at 0%, the deposit rate at minus 0.4% and the marginal rate at 0.25%. They repeated a pledge that borrowing costs will stay at present levels until well past the end of net asset purchases.

The ECB said the proceeds of maturing debt will be reinvested for an "extended period of time after the end of its net asset purchases, and in any case for as long as necessary." It also stressed that lending to banks will be conducted at a fixed interest rate and with full allotment for as long as needed.

Mario Draghi

The decision to curtail QE "reflects growing confidence in the gradual convergence of inflation rates towards our inflation aim on account of the increasingly robust and broad-based economic expansion," Draghi said in a press conference after Thursday’s Governing Council meeting.

"At the same time, domestic price pressures are still muted overall, and the economic outlook and path of inflation are conditional on support from monetary policy."

While Draghi toned down his language, saying the euro area still needs "ample" stimulus instead of the "substantial" used in previous statements, he emphasised the need to tread carefully as long as consumer prices remains weak. 

The decision wasn’t unanimous. A key point of dissent among some policy makers has been whether or not to set a firm end date for purchases.

“I would characterise the discussion as ranging between consensus, broad consensus on some issues and large majority on others,” Draghi said. The decision to keep purchases effectively open-ended was taken by large majority, he said.

The ECB head highlighted additional risks including the strength of the euro, which has risen almost 12% against the dollar this year, potentially depressing price pressures and undermining export competitiveness. 

He also reiterated that governments need to step up their structural reforms "substantially." That could be a key risk as monetary stimulus is pulled back.  

"The door is left open to extend the asset-purchase programme yet again," said Ken Wattret, an economist at TS Lombard in London. "Though the likelihood of this happening for a fourth time looks rather lower now for various reasons, including the positive economic outlook."

The euro dropped after the announcement, trading down 0.5% at $1.1758 at 2:11 pm Frankfurt time, and European government bonds jumped.

Inflation

Investors have for months attempted to guess the central bank's next move, with the drawn out decision-making process highlighting the struggles policy makers face in balancing a stimulus exit with the need to return inflation toward their objective. 

Even after becoming the first major central bank to charge banks for deposits and embarking on a quantitative-easing programme, inflation remains far from the goal of just below 2%. That partly reflects a phenomenon of lacklustre price growth faced by developed economies across the globe, which US Federal Reserve Chair Janet Yellen has called a mystery.

The ECB began large-scale asset purchases in March 2015 -- more than six years after the Fed started its first programme. Germany's Bundesbank has been outspoken against the measure even before it began, arguing that it reduces incentives for governments to make their economies more competitive.

The latest reduction is the second after the programme was slowed this April, and it is widely expected to constitute the final leg of QE as the ECB's capacity to provide more stimulus becomes increasingly constrained by self-imposed rules.

Draghi pushed back on the idea that it is facing limitations.

"Our programme is flexible enough that we can adjust its size," he said. "We can carry it through smoothly, and that's been the evidence we’ve given until now."