ECB should decide on QE sooner rather than later

The ECB must decide whether the impact of inaction would be more costly than if it were to reduce QE. One thing is for sure, time is running out fast.

In July, the European Central Bank President Mario Draghi said that the Governing Council would discuss the future of its €60 billion monthly purchases programme in the autumn. Technically, autumn in the Northern Hemisphere will not start until Friday September 22, so there is a possibility that the topic of QE tapering may not be discussed at this week’s meeting. However, many analysts reckon that an announcement would be made a bit early at this meeting because it coincides with the new ECB staff forecasts. There are a number of reasons why the ECB would want to reduce QE purchases, not least because of bond scarcity. But more importantly, the consequences of acting too late could be very damaging as inflation could spiral out of control. So far, inflation has been contained. But at 1.5 per cent, Eurozone inflation has risen near the ECB’s target of close to, but below, 2 per cent. Core inflation, which strips out volatile elements, currently stands at 1.2 per cent. While there may be a bit more room for prices to rise further in the Eurozone, the current level of inflation means the ECB’s extremely loose monetary policy may be unjustifiably too loose. Surely the central bank would want to have room for manoeuvre in the event the economic situation unexpectedly deteriorates in the coming months or years. Indeed, at the moment things are looking somewhat positive in the Eurozone, with various gauges of consumer and business confidence hitting multi-year highs and corporate earnings growing. That being said, however, one can also understand why the central bank is still hesitant to taper QE. After all, economic growth remains stubbornly low and unemployment high in the Eurozone. What’s more, with the US – the largest economy in the world – struggling, Eurozone exports could suffer in the coming months, particularly given the high exchange rate. In fact, by tightening monetary policy there is a strong possibility the euro would appreciate further, making goods and services even more expensive for foreign purchasers. The strong currency may also weigh on European export-oriented stocks. That is clearly undesirable. Still, a decision has to be made soon. The ECB must decide whether the impact of inaction would be more costly than if it were to reduce QE. One thing is for sure, time is running out fast. The longer it delays the decision, the costlier it may become.

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