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COLUMN-Call it what you like, ECB is tapering and with good reason: James Saft
December 8, 2016 / 9:45 PM / a year ago

COLUMN-Call it what you like, ECB is tapering and with good reason: James Saft

(The opinions expressed here are those of the author, a columnist for Reuters)

By James Saft

Dec 8 (Reuters) - Forget the redefinitions, the European Central Bank is tapering and for good if not happy reasons.

Good in the sense of being its best available option, but those options are not, on the whole, happy ones.

The ECB on Thursday said it would shave 20 billion euros per month off of its asset purchases starting in April, though it gave itself the option, one it surely already had, of increasing again from 60 billion euros afterwards should it see fit.

There could be “no question” of calling this a tapering, ECB chief Mario Draghi said, citing the novel argument that it did not qualify as they did not intend to take purchases down to zero. Draghi’s ultimate intentions, which he himself admits are uncertain, don’t come into it: the pace of bond buying will diminish and that, dear friends, is a taper.

More interesting than the word games are the limitations on ECB actions which look to have motivated what it is actually doing, as opposed to what it may some day do or how it would like its actions to be characterized.

Though the central bank gave itself the freedom to buy lower yielding and sooner maturing bonds it will soon run up against a ceiling of its own making - that the ECB shall not buy more than a third of a given country’s sovereign debt or more of its debt than that nation’s share of euro zone output.

This leaves Draghi twisting himself, and policy, into knots in order to try to at least avoid the appearance of violating the cardinal rule of central banking: thou shalt not show weakness.

“Under no circumstance can the ECB or indeed any other central bank admit that it cannot do ‘whatever it takes’ ... Unfortunately, even if tacitly, that is exactly what the ECB did today,” Marc Ostwald of ADM Investors Services wrote to clients.

“The contention that if necessary, the QE program could be increased to 80 billion euros again is part of the rhetorical camouflage, but it is too easy to see through.”

Remember that Draghi is tapering bond buys, or winnowing them if you prefer, at exactly the same moment as his own staff is projecting that euro zone inflation will average 1.7 percent in 2019, a level he himself characterized as “not really” close to the official goal of a bit under 2 percent.

The fact that the ECB might later change course or buy other assets does little to convince that inflation will soon answer to its commands.

POLICY HAS LIMITS

And it isn’t simply operational reasons which bedevil ECB plans to support the euro zone economy by buying up assets. QE works quite well when markets are in a seriously impaired state, such as towards the beginning of the financial crisis.

For some time now the question facing would-be euro zone borrowers isn’t so much if they can borrow money - they can, and quite cheaply - but if they can profitably put those funds to work. That question is simply less amenable to monetary policy. At best it needs fundamental support through structural reform, something Draghi always stresses, or at least it requires shorter term encouragement via greater government spending.

The longer we go without a strong recovery in inflation while running a very large QE policy and negative interest rates the worse the tradeoffs on this policy become.

“The reality, which we have observed before, is that monetary policy has very likely reached its limits,” Stefan Isaacs of M&G Investments wrote to clients.

“For all the rhetoric that central banks will espouse to the contrary, the reality is that we have reached a tipping point. For each additional measure of monetary stimulus there is an equal or greater cost to be borne elsewhere in the economy - banks, insurers and savers the obvious losers.”

In this respect, the Federal Reserve and President-elect Donald Trump are providing the ECB with some very useful covering fire.

For now, at least, the market has decided that Trump will run an inflationary and expansionary fiscal policy, a belief that’s led to a rapid increase in future inflation expectations, and with it an appreciation of the dollar. The Fed will, almost certainly, raise benchmark U.S. interest rates next week and may well signal a steeper pace of hikes in the months to come.

A steepening global yield curve will help euro zone banks and insurers and will also flatter the outlook for retirement savers, whose future liabilities look bigger at lower longer-term yields. Best of all for the ECB is a stronger dollar, which may deal pain to emerging markets and those who need to attract capital flows, but will help euro zone exporters.

Thursday may have been an uncomfortable time for the ECB to say it was tapering, but it was as good a chance as it may get to do it anyway. (Editing by James Dalgleish)

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