How and when to turn the QE tap off

Tony Ward

September 11, 2017

Tony Ward is chief executive of Clayton Euro Risk

Last week, the European Central Bank decided to keep eurozone interest rates and its bond buying programme unchanged, despite raising its economic growth forecast for this year to 2.2%, the fastest growth in 10 years.

ECB president Mario Draghi said the 19-country bloc grew faster than expected in the first half of the year. He added that the ECB would probably make decisions about its stimulus measures next month.

The ECB is currently buying €60bn (£55bn) of bonds a month as part of its quantitative easing (QE) programme. However, analysts expect this to be scaled back in the months ahead given the eurozone’s recovery.

Meanwhile, the head of Germany’s biggest bank has called for Europe’s ‘era of cheap money’ to end as price bubbles form.

Deutsche Bank chief John Cryan said that while cheap money has helped countries and banks ‘emerge from the financial crisis’, it is now causing ‘ever greater upheavals’ across a number of areas. “We are now seeing signs of bubbles in more and more parts of the capital market where we wouldn’t have expected them,” he said, noting property prices in advanced economies had hit record levels. Making a case for tighter monetary policy, he welcomed gradually ending loose monetary policy: “The central banks must, however, plot a middle way that averts massive losses on the markets,” he cautioned. Wolfgang Scauble, Germany’s finance minister, also chipped in: “Unusual monetary policy implies it is not usual or normal. We should get back to a normal monetary policy.”

Well, yes. The Bank of England, ECB and Federal Reserve are now under increasing pressure to phase out QE programmes but important questions remain. At what timescales and what cost?

I read a good analogy in The Times that suggested that QE was a little like toothpaste in a tube – easy to squeeze out, awkward to put back, assuming that it will go. My thoughts exactly.

Whereas it was probably right to introduce these schemes – many attribute them with staving off a depression – how we wean ourselves off them is the important question. It certainly won’t be simple and, if not handled correctly, could trigger a market panic.

Jamie Dimon, chief executive of JP Morgan Chase, put it quite succinctly: “We’ve never have had QE like this before, we’ve never had unwinding like this before. Obviously, that should say something to you about the risk that might mean, because we’ve never lived with it before.”

So, timing and organisation is all. Central banks may need to prepare markets with months of ‘forward guidance’ to give investors time to adjust their positions and avoid a shock sell-off. It seems to be a little like a game of cat and mouse at the moment.

While the ECB may be sending out messages about winding back QE, it is watching what the Fed is doing. “The ECB was hoping to exit QE under cover of the Fed’s adherence to a predictable path of normalisation”, economists at Bank of America’s Merrill Lynch said. If the Fed doesn’t start unwinding QE soon, the ECB may want to delay its taper.

Still, analysts seem to be expecting Mario Draghi to make a move at the next ECB meeting on October 26, although analysts think actual reductions won’t begin until next year.

Patrick O’Donnell, an investment manager at Aberdeen Standard Investments, said the markets widely expected the bank to announce plans in October on winding back QE. Claus Vistesen, chief eurozone economist at Pantheon Macroeconomics, said: “We think the central bank is trying to send the message that the degree of stimulus will be dialled down as the economy improves, but not removed altogether.”

Let’s wait and see what happens. One thing is certain: the return to monetary normality will take time and we should tread cautiously.

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