European Central Bank meeting: Time called on the asset purchase programme - J.P. Morgan Asset Management

European Central Bank meeting: Time called on the asset purchase programme

Contributors Karen Ward, Global Markets Insights Strategy Team

The European Central Bank (ECB) met today and announced that the pace of asset purchases will be halved from October to a pace of EUR 15bn per month and will be ceased altogether at the end of the year.

However, the Governing Council were keen to emphasise that this does not mean short-term interest rates will rise any time soon. Ultra-loose policy is still required to support economic recovery and bring inflation back to target. As a result all key interest rates will remain at their current levels ‘at least through the summer of 2019’.

This decision was made on the back of new ECB forecasts. Expected GDP in 2018 was revised down from 2.4% to 2.1%. Expectations of growth in subsequent years were unchanged. Expectations of inflation this year and next were revised up due to the recent rise in oil prices. But inflation is still expected to be below target – at 1.7% - in 2020 which highlights the need for ongoing loose policy (exhibit 1).

EXHIBIT 1 : European Central Bank staff macroeconomic projections for the euro area

Source: European Central Bank, J.P. Morgan Asset Management. Data as of 14 June 2018

Today’s policy announcement was in line with our expectations. Although the Eurozone economy still requires supportive monetary policy, asset purchases were beginning to do more harm than good, in our view.

Remember that the central bank had to purchase assets indiscriminately - it was not able to pick winners and losers. This prevents the healthy functioning of the bond markets which reward debt issuers – both governments and corporates - for good behaviour. Governments need the discipline of the free-functioning market as an incentive to focus on sound sustainable policies which promote growth in their economies and businesses. Stepping back from quantitative easing (QE) will insulate the ECB from potential criticism that it is funding the fiscal largesse associated with certain populist policies (given the recent election in Italy, this was an increasing risk).

The ECB will likely be pleased with how this policy change landed in the financial markets. Despite the announcement of the end of QE, the euro fell by about 1% against the dollar. There was a small decline in long-term yields in Germany and France while Italian yields were broadly unchanged. Most major European equity markets rose in reaction to the announcement.

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