Frankfurt am Main (AFP) – European Central Bank policymakers are set to discuss Thursday whether to withdraw their mass-bond-buying programme later this year, in a major vote of confidence — but also a risk — for the eurozone economy.
Here are five things to know about what the so-called “quantitative easing” (QE) programme is and why the decision matters for the 19-nation single currency area.
– Why was QE launched? –
President Mario Draghi announced in January 2015 that the ECB would expand its interventions in financial markets with mass bond-buying.
After the financial crisis, the central bank’s previous attempts to lift inflation towards its target of just below 2.0 percent — smaller asset purchase programmes and lower interest rates — had not done the job.
Steady inflation is seen as vital for healthy economic growth as it wards off deflation, or a spiral of decreasing prices that encourages people to hoard money rather than spend it.
– What is QE? –
QE is shorthand for the central bank creating money and using it to buy government bonds or other financial assets on the open market.
The aim is to encourage investors to move cash out of low-risk holdings like bonds and seek returns elsewhere, for example by lending to households and businesses.
In turn, those people and firms will spend money, powering economic growth and, so the theory goes, inflation.
As it manages a currency shared between 19 countries, the ECB’s programme faces more constraints than those at the Federal Reserve in the United States, the Bank of England or the Bank of Japan.
The most important of these is a ban on the ECB buying too many of any one country’s bonds, designed to avoid accusations of “monetary financing” — or the central bank footing the bill for government spending.
Some observers argue the central bank is approaching these limits, while others believe it can find more wiggle room to continue if needed.
– Has it worked? –
QE has made it easier for eurozone companies, households and states to borrow money, saving them billions on interest payments.
Eurozone growth hit its highest level since 2007 last year, at 2.3 percent, while unemployment has fallen to its lowest levels in ten years, at 8.5 percent in March.
There has been “some moderation” in early 2018, Draghi said in April, but “growth is expected to remain solid and broad-based”.
However, the bank only touched its primary objective, the inflation target, last month after more than 2.4 trillion euros ($2.8 trillion) of purchases — likely thanks to one-off factors like higher oil prices that could fade over the rest of the year.
Internal ECB forecasts from March see inflation averaging 1.4 percent this year, rising to just 1.7 percent by 2020.
– Why is it difficult to end? –
The ECB wants to avoid any statement that would upset financial markets, after watching the “tantrum” among investors when the Fed abruptly announced in 2013 that its purchases would end.
Frankfurt policymakers have sidled up to the decision, reducing monthly purchases to 60 billion euros from 80 billion euros in April 2017, then halving them to 30 billion euros from January this year.
A slew of threats to eurozone growth that have appeared in recent months could prompt further caution.
US President Donald Trump appears eager for a trade war with Europe.
Meanwhile a newly-elected populist government in Italy with big-spending plans could tip the eurozone’s third-largest economy into financial crisis and there is so far no agreement on Britain’s future trading relationship with the EU after it departs the bloc early next year.
And higher oil prices have helped to lift inflation in the short term — but could also weigh on future economic expansion.
One bright spot for policymakers is a euro that has weakened slightly against the dollar, to around $1.18, although the exchange rate mostly reflects investors’ fears over Italy.
A stronger euro would brake inflation as imports become cheaper and growth in European exports slows.
– How does the ECB plan to do it? –
Most observers long expected the ECB to outline in advance a series of reductions “tapering” its bond purchases to zero.
But given the range of risks and unsatisfactory inflation, many now predict a “flexible” exit from QE that will see the ECB take one step at a time.
At his last press conference in April, Draghi stuck to his long-held mantra of “patience, prudence and persistence” in describing his approach.
Meanwhile the ECB will renew its vast stock of government and corporate bonds as they mature, helping keep financing conditions comfortable for states and firms.