End to ECB Stimulus Shakes Markets, But is 'Taper Talk' Just a Misunderstanding or a Real Possibility?

Is it likely the European Central Bank will begin reducing its stimulus purchases as rumours suggest, or are investors guilty of jumping the gun when it comes to speculating on policy?

The Euro strengthened on Tuesday afternoon after rumours spread that the European Central Bank was planning to dismantle its stimulus programme, by ‘tapering’ its injections step-by-step.

Stimulus keeps the Euro weak by reducing interest rates and diluting individual unit value.

Lower interest rates attract less foreign capital which tends to gravitate to states with higher rates of interest, that can, therefore give investors higher returns.

The news that the ECB was to reduce stimulus, therefore, helped lift the value of the Euro.

Stock markets on the other hand fell with the prospect of fading 'easy money' casting doubts on the future growth profile of the Eurozone and global economy.

The bullish sentiment that has driven early October's sensational rise in the FTSE has been dampened, "with markets largely responding to the fears that perhaps the seemingly unlimited ECB QE could be limited after all," notse Chris Beauchamp at IG in London.

"Rumours of exit plans being drawn up at the ECB highlight the growing feeling that Draghi & co are facing up to a exhaustion of monetary policy policies and effectiveness," says Beauchamp.

Given most analysts were given to expecting the ECB to do the opposite and increase stimulus, it comes as a surprise that policy makers should be discussing the opposite. 

So is there any substance to the rumours and what could they?

The rumours originated from an article by Jana Randow, Alessandro Speciale and Jeff Black, published on Bloomberg and entitled, “ECB Said to Build Taper Consensus as QE Decision Time Nears.”

The article’s sources are anonymous ECB officials who said that an “informal consensus,” had been built amongst the ECB’s rate setters that the governing council should begin tapering the stimulus programme (otherwise known as QE, or quantitative easing) before the end-date to the programme had been reached.

“The European Central Bank will probably gradually wind down bond purchases before the conclusion of quantitative easing, and may do so in steps of 10 billion euros ($11.2 billion) a month, according to euro-zone central bank officials.”

It appears the process could begin as soon as a decision for a definitive end-date has been made.

“An informal consensus has built among policy makers in the past month that asset buying will have to be tapered once a decision is taken to end the program, the officials said, asking not to be identified because their deliberations are confidential.”

The article’s sources stressed, however, that although tapering had been discussed, the final end-date for QE might be delayed from its current March 2017 deadline.

“They didn’t exclude that QE could still be extended past the current end-date of March 2017 at the full pace of 80 billion euros ($90 billion) a month,” said the Bloomberg story.

The Bloomberg report suggests the discussions about tapering were influenced by the ECB’s concerns that it is having to shoulder most of the burden of stimulating the economy through monetary policy and governments were not trying hard enough to use fiscal stimulus despite the environment of ultra-low borrowing costs.

A further reason given for possibly considering tapering is the scarcity of bonds available for purchasing as part of the ECB’s QE stimulus programme.

The ECB cannot buy bonds which have a yield below the -0.4% deposit rate and as the QE programme has progressed and global factors have influenced the markets more and more bonds have fallen below -0.4% and become ineligible.

The chart below shows how German bond yields have fallen progressively since the start of the QE programme.

It shows that now even 5-6 year bonds are not eligible for purchase, leaving only the longer maturity bonds.

The emphasis on longer-dated debt may, however, result in a flattening of the yield curve which would be detrimental to Eurozone banks, which are already struggling to remain profitable.

This happened in Japan before the BOJ introduced targeting purchasing at their last meeting, in order to steepen the yield curve again and help banks to increase profitability.

The strangulation of lending by Eurozone banks due to low profitability, which is itself a symptom of low-interest rates resulting from the ECB’s extra-loose policies is itself a reason to suspect that the ECB might be keen on starting  tapering sooner rather than later.

Moneycorp linked the taper talk to observations by two senior ECB officials concerned about how Eurozone banks were finding it harder to lend in current conditions.

“The news (of taper) was released in the context of recent observations by two senior ECB folk, chief economist Peter Praet and board member Yves Mersch, who noted that banks with lower share prices tend to lend less.

“One reason for lower bank share prices is that negative interest rates hit their profitability, making them a less attractive investment.

“Uninvestable banks lending less money is not at all what ECB monetary policy aims to achieve.

“So investors put two and two together and, bingo! The ECB must be preparing the way for an early end to the QE scheme!

“The euro jumped a cent higher against the US dollar,” stated the Moneycorp research note.

Nordea Bank do not expect tapering to begin until the second half of 2017 as they expect the ECB to extend their stimulus programme by another 6 months.

“We believe that ECB will extend the APP beyond March next year by 6 months before tapering commences as an abrupt halt would severely impact the market,” said Nordea.

The remind readers that it took Ben Bernanke 18 months to introduce tapering from when it was first mentioned.

“Therefore, we believe that it is premature to expect tapering is just around the corner. Lessons from the US show that the previous Fed chair Bernanke first mentioned taper nearly 18 months before they eventually started, “said Nordea.