The European Central Bank plans to scale back its bond-buying program starting in January, but policy divisions persist between the doves and the hawks.

The European Central Bank (ECB) announced in October that it will reduce its bond-buying program to 30 billion euros a month from 60 billion euros starting in January. The gradual withdrawal of so-called quantitative easing (QE) was designed to placate both hawks and doves at the bank, and reduce volatility in financial markets. The fact that an end to the bondbuying program is in sight matters to the hawks, while the commentary that stressed rates were likely to remain very low was designed to placate the doves. The next policy move, or the next battle line between hawks and doves, will be the negative deposit rate. This is deeply unpopular in Germany, and it doesn’t seem to help much when the ECB really wants banks to be profitable and expand credit. ECB President Mario Draghi will need to find a way to move deposit rates higher without signaling a move in the overall structure of interest rates.

ECB to wind down stimulus program

The ECB had flooded the economies in the region with easy money to promote growth, lower interest rates, and push inflation higher. The winding down of the massive stimulus program comes as growth in the eurozone gathers pace. Real activity data have continued to provide small positive surprises: Italy’s manufacturing Purchasing Managers Index (PMI), and Belgium’s business confidence indicator rose, while Germany’s Ifo Business Climate Index showed a strong reading in October. However, recent inflation data was a disappointment to the market, with shortfalls in the euroland core rate and headline inflation rates in Germany and Italy. The data is enough to matter for the ongoing struggle between the hawks and the doves on the ECB Governing Council. According to our eurozone forecast, inflation looks a bit higher at the end of the forecast horizon. Our guess is that ECB staff forecasts are beginning to show the same upward drift.

ECB President Mario Draghi will need to find a way to move deposit rates higher without signaling a move in the overall structure of interest rates.

Next: Wage inflation remains sluggish


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October marked another month of global expansion, and financial markets remained upbeat against a backdrop of low inflation.