One by one, the big central banks are edging back to something that feels like normality. Following the lead of the US Federal Reserve, the European Central Bank on Thursday announced that it would halt the programme of quantitative easing on which it embarked in 2015 amid a seriously weak economy and the threat of corrosive deflation.
At first sight, the move may look premature. The ECB is betting that the softness seen in many indicators of the eurozone economy in recent months will prove a temporary weak spot rather than something more serious. The history of central bank expectations — not just in the eurozone — over the past decade is one of habitual over-optimism, particularly of the ability of the economy to generate enough growth to fulfil the economy’s output capacity and generate higher inflation.
Yet more important than this particular decision is whether the ECB maintains the activist stance it has taken throughout Mario Draghi’s time as its president — a tenure which, regrettably, is to end next year. The bank must keep the crisis toolkit that it has assembled over the past decade well oiled and ready to redeploy if Europe’s economy should weaken again.
The recent news from the eurozone economy has generally not been good for a number of months. Forward-looking surveys, including purchasing managers’ indices and the European Commission’s own soundings on consumer and business confidence, in general came off highs early in the year and continued to slide since the summer. Eurozone gross domestic product has also decelerated during 2018, recording a feeble outcome of just 0.2 per cent growth in the third quarter of the year.
Indeed, even as it announced its exit from QE, the ECB on Thursday lowered its forecasts for both growth and inflation in 2019. The bank is betting that recent higher wage inflation will be sustained and will feed through to consumer price inflation before too long. Mr Draghi himself conceded that the risks were now tilted to the downside, and spoke of “continuing confidence with increasing caution”.
On any reasonable definition of the ECB’s goal of inflation “close to but less than 2 per cent”, using the core measure of consumer prices, the bank has consistently missed its target for nearly a decade. It is hope rather than confident expectation that the long-awaited rise will finally come through this time.
In the future, even more important than Thursday’s decision is for the ECB to remain poised to react again quickly if growth goes into a sustained period of weakness and wage and consumer price inflation start to head downwards again. On Thursday, the ECB gave itself the flexibility by announcing it would reinvest fully bonds that come due to maintain the stock. It also has other measures, such as targeted longer-term refinancing operations, to encourage bank lending. Mr Draghi wisely said that while TLTROs were not discussed at this particular meeting, they remained under consideration.
All central banks, including the Fed, should guard against the assumption that extraordinary tools such as QE in the decade after the crisis were a one-off never to be repeated. Inflation remains low across much of the developed world, and after such a long — and often sluggish — recovery, the prospect of a downturn means they may well be needed again.
Mr Draghi’s most important legacy will be, as he once said, for the ECB to do “whatever it takes” to restore growth and stability to the eurozone. The ECB has announced the cessation of asset purchases under QE. It may well turn out to be a suspension rather than a definitive full stop.
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