Mario Draghi’s silence on the future of quantitative easing is complicating a key aspect of the European Central Bank’s policy process.
The ECB president and his colleagues typically back up shifts in strategy with their economic projections, which are based on market indicators that include expectations for future policy. Except that less than four months before the current asset-purchase program is due to end, the Governing Council hasn’t provided any details on the scale of stimulus beyond 2017.
The upshot is that investors are being forced to second guess the ECB’s intentions, potentially leaving Draghi with a set of economic forecasts skewed by their perspectives on growth and inflation. While uncertainty in forecasting is a perennial problem for any central bank, it’s especially critical for the ECB right now as officials start to deliberate how fast they might be able to bring unconventional stimulus to an end.
“The ECB is setting its monetary policy based on forecasts, which are based on asset prices which reflect the market’s best guess about what the ECB will do,” said Richard Barwell, an economist at BNP Paribas Asset Management in London. “The whole thing is circular.”
The Governing Council starts its two-day policy meeting on Wednesday, when it will receive the latest update to its economic projections, and expectations are high that it’ll hold formal discussions for the first time on its stimulus options for next year. Robust and increasingly broad economic growth has stoked speculation that asset purchases, scheduled to run at 60 billion euros ($71 billion) a month until at least December, will be wound down even while inflation remains below target.
BlackRock’s Isabelle Mateos y Lago expects a one-step reduction to as low as 30 billion euros a month, while Collineo Asset Management forecasts policy makers won’t start to pare back asset purchases until the end of 2018 and will take two years to wind down the program. Economists surveyed by Bloomberg predict the ECB will gradually taper buying over nine months from January.
Investors could be kept waiting for a definitive decision. The Governing Council may not be ready to finalize its strategy until December, according to people familiar with the matter. While officials are aware they shouldn’t keep investors in the dark until the final session of the year, they may only be able to deliver general indications this week or at the next policy meeting on Oct. 26.
The ECB says its projections, which are updated quarterly, are built on forward market prices such as interest rates, assets, oil and exchange rates. Those can change radically — the euro has appreciated more than 7 percent since mid-May, the cut-off date for the previous round of forecasts. In addition to its standard formulas, the central bank relies on satellite models and equations to gauge the impact of non-standard policy.
Draghi was elusive in June when asked about how much central-bank support the latest forecasts entail. His reply was that the predicted pickup in inflation is predicated on a “very substantial amount of monetary accommodation” and “that’s what it is in the projections.”
The Bank of England also uses market rates to underpin its quarterly Inflation Report, which backs its policy decisions. Sweden’s Riksbank tells investors how it sees interest rates developing over the following three years, and bases its growth and inflation forecasts on that path.
The ECB economists avoid making any prejudgments of their own about what the Governing Council might or might not do. At the same time, it’s difficult for them to gauge investor expectations for unconventional stimulus.
“It’s simpler with rates, you can look at the market curve and say ‘markets are pricing a 30 basis point cut’ and then you know that’s what the staff are assuming in their forecasts,” said Greg Fuzesi, an economist at JPMorgan Chase & Co. “With non-standard measures it’s much harder to know what exactly the markets are pricing in.”
Nonetheless, Draghi’s economists have attempted to gauge how growth and inflation would pan out through 2019 if current stimulus measures weren’t in place — as shown in a chart used in public presentations by Vice President Vitor Constancio and Director General for Economics Frank Smets.
Ultimately though, that’s still an estimate reliant on market prices. For BNP’s Barwell, the better way would be less focus on investors and more on projections built on the ECB’s own assumptions.
“They should stop the pantomime and publish internally consistent forecasts for growth, inflation, policy rates and QE instead,” he said.