Fitch: ECB Hits Dovish Note, but End of Eurozone QE is in Sight

The ECB’s announcement that it will extend purchases under its asset purchase programme (APP) until at least September next year does not signal an indefinite extension of quantitative easing (QE) in the eurozone, Fitch Ratings says. We believe purchases will end in 2018, given the strength of the bloc’s economic recovery and the likelihood that core inflation will continue to rise slowly.

The ECB said on Thursday that it would extend APP purchases until the end of next September “or beyond”, and “in any case until the Governing Council sees a sustained adjustment in the path of inflation” consistent with its target. The monthly rate of net asset purchases will halve from January, to EUR30 billion, but the ECB could increase the size or duration of purchases if necessary.

In our most recent Global Economic Outlook (September 2017), we forecast that the ECB would make its final purchases under the APP in June 2018. Thursday’s announcement extends purchases to end-3Q18 – and implies larger-than-anticipated cumulative purchases in 2018, at EUR270 billion, but we still think that improving macro conditions will see purchases phased out next year.

The increasing strength, breadth and duration of the eurozone recovery point to some self-sustaining momentum, and we upgraded our 2017 growth forecast by 0.2pp to 2.2% in September. This would represent the fastest growth in a decade. Meanwhile, the closing of the output gap should help cement expectations that inflation will continue to rise towards the ECB target of below, but close to, 2%. We forecast eurozone CPI to rise to 1.6% at end-2018 and 1.7% a year later.

The option of increasing or extending purchases again reflects the view, consistently argued by Mario Draghi, that the eurozone recovery is still strongly dependent on monetary support. But he also reiterated on Thursday that the large stock of ECB asset holdings (over EUR2 trillion) is a source of this support, implying that support is less dependent on the monthly flow of purchases. Draghi also stressed that reinvestment flows would be maintained.

Overall, the announcement is consistent with our view that we are at the beginning of the end of QE globally, even if inflation stays low. QE’s broad aim of avoiding self-reinforcing deflation has been largely achieved in the US and the UK as well as in the eurozone.

However, the announcement also hints at the technical and communications challenges that central bankers face as they start to unwind balance sheets and raise policy rates. (Thursday’s ECB’s forward guidance on interest rates, which will remain at their present levels “for an extended period of time, and well past the horizon of the net asset purchases”, was unchanged.) The impact on global financial conditions is uncertain, and the dovish tone in the ECB announcement may reflect a desire to avoid rises in government bond yields and euro appreciation, which could push inflation expectations lower.
Source: Fitch Ratings