March 22, 2019

Europe jumps off easy money train

An era has ended at the European Central Bank.

On Thursday, European Central Bank President Mario Draghi announced that the bank would stop its massive bond-buying program at the end of December. The policy, known as quantitative easing or QE, has seen the ECB buy €2.4 trillion worth of government debt in the last three years to help pull the eurozone out of recession. Draghi is now signalling to eurozone governments that his job is done and that they must pick up the baton.

The ECBs decision wasnt a shock after Peter Praet, its chief economist, hinted at it last week. But it still came as a surprise when judged against the repeated “dovish” messages the central bank has sent in recent months.

The Frankfurt institution reserved the right to change course, depending on “incoming data,” and it has always insisted on keeping open the possibility to resume the bond-buying program at any time, if need be. But if inflation continues to converge toward the ECBs “below but close to 2 percent” target, QE à lEuropéenne will have stopped by year-end.

Uncertain circle to square

The ECBs decision raises questions about its future monetary policy, its impact on the eurozone political debate, and the particular situation of Italy.

The programmed end of QE, with only three months of so-called “tapering” between October and December when monthly bond purchases will halve to €15 billion, may not fit well with Draghis own warning that the eurozone economy is facing “increasing uncertainty, for mostly geopolitical reasons.”

But the ECB preferred to look at the current situation characterized by “a strong economy,” as Draghi also noted, and the likelihood that it would soon reach its inflation target — the ECBs only remit by treaty.

That doesnt mean the ECB is just abandoning the eurozone to its macroeconomic fate. Interest rates will remain negative “at least through the summer of 2019.” And the ECBs balance sheet wont shrink anytime soon: The central bank will keep the €2.4 trillion worth of bonds it has acquired over the last three years and reinvest in eurozone sovereign debt when they mature.

That will provide continuous support for governments, keeping bond markets under pressure.

Et vous, Berlin, Paris … and Rome?

The second question is what eurozone governments will do now that the ECB is stepping down.

In political terms, France and Germany will feel increased pressure to come up with a credible plan to shore up the monetary union at the European summit at the end of the month. Thats when they are due to present their partners with a plan for both immediate reforms and further steps to be taken in the coming years.

More generally, eurozone governments will have to devise ways to shield their economies from the possible effects of rising interest rates in the coming months.

Italy looked like a special footnote in the ECB decision. Draghi, as every central banker is bound to do, reiterated that the eurozone is here to stay and that anyone betting on its demise would be sorely disappointed.

But he also warned that the strength of the blocs economy would depend on governments not starting discussions that would “destroy the progress already made” politically during the crisis — meaning the relatively new consensus on serious structural reforms and sensible fiscal policies.

The two parties in Italys new coalition government ran campaigns that were strident in their criticism of the EU and the euro. But the tone is suddenly more subdued in Rome. The strong Europhile interview earlier this week that Italys new Finance Minister Giovanni Tria gave to Corriere Della Sera no doubt went a long way to reassure Draghi.

But some things obviously go better when said again, just in case.

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