ECB holds rates but signals changes to quantitative easing

The European Central Bank will extend its landmark quantitative easing programme for a further nine months, but will buy a lower amount of bonds than the current monthly level, it confirmed on Thursday in a move that took some market-watchers by surprise.

The bank also kept interest rates on hold as expected.

Political instability in Italy following Sunday’s defeat of a referendum on constitutional reform had raised expectations that the bank might continue its asset-buying programme past next March. But in a move that was seen as a compromise between hawkish and dovish positions on the ECB’s governing council, the central bank said it would continue its bond-buying programme after next March but at a slower pace, reducing the amount of purchases from €80 billion to €60 billion.

Programme

Speaking after the meeting in Frankfurt, ECB president Mario Draghi stressed that the bank was leaving open the possibility of increasing the size and scope of the programme before then if needed.

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"If, in the meantime, the outlook becomes less favourable or if financial conditions become inconsistent with further progress towards a sustained adjustment of the path of inflation, the Governing Council intends to increase the programme in terms of size and/or duration," he said, quoting from a statement issued by the ECB.

The euro initially advanced on the back of the announcement at lunchtime but fell, along with bonds, by close of business.

The ECB’s quantitative easing programme was launched in March 2015. Recent euro zone data had strengthened the case for tapering the asset-purchase programme after next March.

But the defeat of Italy's referendum on constitutional reform and the subsequent resignation of Prime Minister Matteo Renzi, put pressure on the ECB to signal some form of continuance of the programme, amid fears about the health of the Italian economy and the state of the country's financial sector.

Tapering

Speaking during a press conference after the decision, ECB president Mario Draghi denied that the scaling-back of the asset-purchasing programme was tapering. “Tapering has not been discussed today,” he said.

The reduction of the scale of the programme from €80 billion to €60 billion a month took some investors by surprise, who had been expecting the €80 billion level to be maintained.

In his press conference, Mr Draghi outlined the political uncertainty facing the euro area next year.

“Just look at the election calendar for the year to come and that is by itself a source of uncertainty,” he said. “There is a big uncertainty, much of which is political, and whether we can do something about that or not is an open question. I think what the central banks can do is to keep a steady hand.”

He also specifically referenced the Brexit vote in June and the US presidential election.

“All of these events, especially Brexit and the new administration in the U.S., have effects that are, by their very nature, going to develop their full dimensions in the medium- to long-term,” he said. “So we’ll certainly see consequences,” though they are “very, very difficult to assess now.”

Bank stocks were also boosted after the ECB announced a change to the criteria for purchasing sovereign bonds, broadening the maturity rate for eligible securities and allowing bonds yielding below the ECB’s deposit rate to be purchased.

In a note to clients, Barclays Research said it expected the ECB to continue quantitative easing into 2018. “The euro area economy will continue to require a high degree of monetary easing, albeit at a lower pace than currently.”

– (Additional reporting: Reuters)