The European Central Bank looks set to brush aside concerns about stiffening economic headwinds and begin discussions about how to wind down its €2.4tn bond-buying programme this week.
ECB officials have long hinted that they would use the summer to lay out plans to end quantitative easing.
When they began to think through their exit plans last year, the eurozone’s recovery looked as though it would be strong enough to withstand the withdrawal of stimulus.
They have done little since to correct expectations that monthly asset purchases would be phased out from €30bn in September to zero by the start of 2019.
Some on the governing council even explicitly said that investors had it right in forecasting the first rate rise to come around the middle of next year.
Yet, as central bankers prepare to meet in Riga on Thursday to begin fleshing out their plans, investors are jittery. Some have pointed to political uncertainty in Italy, higher oil prices and a trade war with the US as reasons to assume that bond-buying could last until spring 2019.
So markets were taken aback last week when the ECB’s chief economist Peter Praet confirmed that the plan remained on track.
“Mr Praet’s remarks gave the impression that the outlook is becoming more clear at precisely the time when uncertainty and downside risks are increasing,” said Ken Wattret, economist at IHS Markit, a data firm. “It’s not just about Italy, look at the G7 meeting.”
Investor nervousness owes something to the idiosyncrasies of policymaking in Frankfurt, too.
To appease the governing council’s hawks, the ECB had to design QE in a way that limited its firepower.
There are constraints on the share of a government’s bonds available for purchase; buying is calculated in proportion to a country’s economic weight rather than outstanding debt; and risk is left largely on the books of the national central banks.
Some analysts suspect that the bank is convincing itself that economic conditions are strong enough simply because it is running out of assets to buy without running into legal constraints.
There is an added concern. With Mr Praet and ECB president Mario Draghi both leaving the bank next year, bank watchers are starting to ask questions about what its next generation of leaders, possibly more hawkish, would do should growth in the region halt in the years ahead.
The ECB’s current leadership will face an increasingly delicate balancing act because there is only so much information they can credibly offer investors.
Richard Barwell, economist at BNP Paribas Asset Management, said: “There is a massive discontinuity between the message that they will end QE at the end of the year, which is now abundantly clear, that they intend to make the first rate hike at some point before or during the autumn of 2019, and what will happen after that when Mr Draghi goes.”
For now, investors will be satisfied with more information on what comes immediately after QE, above all what will happen to interest rates.
The 25-member council has given conflicting signals on how much more it is willing to say on the timing of rate rises beyond their current message that borrowing costs are expected to stay at record low levels until “well past” the end of net asset purchases.
Mr Draghi signalled earlier this year that the bank wishes to raise rates gradually and not in steep steps.
But other policymakers have objected to laying out a clear path for the timing of tightening rates. Ardo Hansson, Estonia’s central bank chief, said last week that the bank may raise rates quicker than the market suspects.
Markets also want the council to make clear how long it will continue to spend the proceeds of maturing bonds bought under QE.
The bank has indicated it will reinvest an average of €15bn a month during the opening four months of 2019, but has given little hint of what will happen beyond this point.
The expectation is that the ECB will follow the Fed’s lead and raise rates before it begins to shrink its balance sheet, but markets may need to wait until July to find out for sure.
When the ECB has taken big decisions in the past, it has tended to do so in two steps — first communicating the tenor of the debate, before revealing the fine print six weeks later.
However, Mr Praet’s confidence in the economy has raised expectations that the chief economist will present a detailed list of options to the rest of the council as soon as this week.
“A formal announcement in July still looks the more likely,” said Mr Wattret. “But the chances of a decision in June have increased based on the tone of Mr Praet’s speech, plus the tactical argument to get on with it before the window of opportunity closes.”
Coming at a time of heightened market sensitivity over Italy, Mr Praet’s remarks drove the gap between German and Italian government borrowing costs wider. The gap has since narrowed following new Italian finance minister Giovanni Tria’s declaration over the weekend that Rome remains committed to the euro.
Rather than a headwind to ending QE, policymakers could see events in Italy as an opportunity to move ahead of the curve.
Mr Barwell said: “If you wait until July and the data gets worse, what do you do then?”
He added: “The bank wants investors to understand that the Draghi put is over, that there are strings attached to ‘whatever it takes’ and that the ECB will not continue with QE just to contain a rise in borrowing costs in Italy.”
Additional reporting by Kate Allen