Thursday night is an important moment on this week’s economic calendar, with the European Central Bank (ECB) expected to announce a reduction in its long-running monthly bond purchase program.
According to Marco Valli, chief economist at Italian bank UniCredit, the reduction will be higher than the median market forecast. However, Valli expects the ECB will use other policy tools at its disposal to prevent an overly hawkish reaction from the market.
The announcement will be closely watched given its potential impact across asset classes, particularly the euro currency.
Valli expects the ECB will announce a revised purchase amount of 30 billion euros per month. His baseline forecast is for the revised purchase program to run for 12 months from January 2018, resulting in total bond purchases next year of 360 billion euros.
That’s a monthly reduction of 30 billion euros from the current policy settings of 60 billion euros. It’s also a bigger cut than the median forecast of 40 billion euros, taken from a Reuters poll of economists in September.
In addition, Valli said that implementation risks are “tilted toward lower purchases”, given the relative scarcity of euro-area bonds which will actually be available to buy.
“Our estimate of 360 billion euros in net asset purchases next year assumes that the ECB would be able to meaningfully step up purchases of German state bonds, which, however, is a rather illiquid market,” Valli said.
“If the ECB does not feel confident that will be possible, it would have to settle for a smaller dose of additional QE.”
Such a scenario may mean that the 30 billion monthly repurchases may only run for nine months, or the annual target would be reduced to 20 billion euros per month.
At the same time, Valli noted that recent communication from the ECB’s Governing Council (GC) hints at the use of other policy tools which will cool hawkish sentiment in the market in response to any changes in policy.
“This probably reflects some uneasiness on the part of the GC about the market still putting too much emphasis on the monthly flow of net purchases,” Valli said.
Policy makers may be wary of the impact of a stronger currency on the Eurozone economy’s recent growth trajectory.
He outlined a number of communication strategies the GC could adopt “to add a more dovish flavor to the tapering announcement”.
One such measure to keep an eye on will be whether the ECB provides any specific guidance on the amount of maturing bonds in its portfolio that will be reinvested. Reinvesting bonds would have the effect maintaining liquidity in the financial system.
While the ECB will always keep its options option, Valli said that right now the bank has no plans to extend its bond purcahse program beyond next year.
“The bar for a further extension of the quantative easing (QE) program into 2019 is high and, in our view, this contingency mainly hinges on a negative shock hitting the Eurozone economy,” Valli said.
As for a potential rise in interest rates, ECB president Mario Draghi said last week that any increase in rates would only occur “well after” the conclusion of the bond-purchasing program.
Such a scenario suggests an increase in Eurozone interest rates is unlikely until relatively late in 2019.
While the Eurozone economy has shown positive signs of growth this year, annual core inflation growth of 1.2% in September remains well below the ECB’s 2-3% target range.