European Central Bank to End Easy-Money Era in Response to US Fed’s Policies

The eurozone’s monetary authorities are seeking to prevent risks of disinvestment and capital flight by tightening their policies – in line with the US Federal Reserve’s increases in interest rates.
Sputnik

Kristian Rouz — The European Central Bank (ECB) has reportedly decided to wrap up its ultra-accommodative policies, known as monetary easing, which have defined the regulatory environment of the European financial sector for the past decade.

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The move is reportedly motivated by the US Federal Reserve's ongoing increases in base interest rates, and the ECB is seeking to tighten its own policies to prevent capital outflows from the eurozone to the US.

Additionally, ECB policymakers have been encouraged by the recent economic acceleration across the eurozone, as the 19-country bloc has apparently recovered from the consequences and aftershocks of both the global financial crisis of 2008-2009 and the European debt crisis of the early 2010s.

"Next week, the ECB Governing Council will have to assess whether progress so far has been sufficient to warrant a gradual unwinding of our net purchases," the ECB's chief economist, Peter Praet, said.

ECB Turns to US Fed for Clues on Policy Normalization
The ECB's upcoming policy meeting is slated for June 14 and will take place in Latvia, albeit a decision on base interest rates and central bank bond purchases will still be made in Frankfurt.

Praet specifically referred to the ECB's bond purchases, which are designed to provide money to commercial banks and the broader financial system by buying debt securities across a variety of sectors of the eurozone's economy. Currently, the ECB is buying some $35 billion worth of bonds per month.

This program was introduced back in 2015 in order to spur the eurozone's economic recovery, and the ECB is currently facing a major challenge pertaining to the bond-buying scheme — there are not enough bonds to be purchased in the open market.

Meanwhile, the bond-buying program is also designed to spur inflation across the eurozone, which is currently heading towards the ECB's 2 percent target.

"The bottom line is that this is the end," Nick Kounis of Amsterdam-based ABN Amro Bank NV said. "This is a signal that the ECB judges that the inflation conditions to wind down net asset purchases have been met."

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The ECB has recently ramped up its purchases of German bonds in order to meet its quotas; but the German authorities have opposed this move saying the ECB's activities could destabilize the already-robust German economy. Berlin unequivocally signaled that the ECB should either buy bonds elsewhere or take steps to end the policy.

One possible option could be Italy, which is still struggling to overcome the banking crisis that shook the nation's financial system in early 2017. However, Italy is currently facing elevated political risks, which have contributed to the ECB's policymaking over recent months — in particular, renewed concerns that Italy may leave the eurozone.

"For what it's worth, the ECB has recently decided to look through political events," experts from Switzerland-based investment bank UBS wrote. "Moreover, some countries may have an interest in reducing the support to a populist government. After all, the QE program also entails buying Italian government bonds."

European investors say the ECB might also raise its deposit rate by 0.1 percent next September, ending its negative interest rates regime (NIRP). Besides, the ECB could also hike its base borrowing costs, currently zero percent.

READ MORE: European Central Bank Stirs Uncertainty With Hints at Policy Normalization

This comes as the US Fed's base interest rates stand at 1.75 percent, as America's central bank is widely expected to increase its borrowing costs to 2 percent in the coming weeks, whilst in the medium term, US rates could go up to 2.75-3 percent.

This would make money more expensive in the US, meaning European investors would be increasingly inclined to pull their capital from the eurozone and move it across the Atlantic. The ECB is thus trying to prevent this, as such a scenario bears a threat of disinvestment for Europe.

Some experts doubt the ECB's ability to adequately address the challenges it faces, not least due to the central bank's inefficient policy communication to open market participants.

"Accelerating the end-date announcement due to fears of an even more clouded economic outlook later on, fuelled by policy uncertainty, would do little to enhance the ECB's credibility," Anatoli Annenkov of Societe Generale said.

At this point, the ECB is weighing its options of either wrapping up its bond-buying more aggressively, whilst keeping rates unchanged for a while, or tightening both its bond-buying and rates.

Investors are betting on the former option, as it would allow the ECB to maintain the fragile balance within the eurozone, where several individual countries are facing a very diverse set of domestic issues — such as the lingering Greek debt conundrum, and Italy's slow recapitalization in the banking sector.

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