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Opinion 25 June 2018

A touch of certainty

After several years of unconventional monetary policy, the European Central Bank has announced an important step toward monetary normalization: the withdrawal of its asset-purchasing program, known as Quantitative Easing (QE), which began in 2015. From September, the ECB will reduce its purchases by half until the program is fully retired in December. In doing so, the institution is following in the footsteps of the U.S. Federal Reserve. The next phase—rate increases—will not occur until the summer 2019, at the earliest, according to guidance issued by the ECB, which thus provides a trace of certainty in an otherwise uncertain global economic landscape.

As the guardian of price stability in the eurozone, the ECB faces a considerable challenge: on one hand, bringing monetary conditions in line with the positive economic environment—the central bank estimates growth at 2.1 percent in 2018 with inflation expected to rise to 1.7 percent this year and the following—without roiling the debt (interest rates) and forex (euro) markets.

The magnitude of the 2008 crisis led the institution to adopt unconventional monetary policy measures such as negative interest rates and asset purchases. In difficult times that called for a cogent response, the measures introduced coincided with the ECB’s new functions: to preserve the euro and a new mandate for banking supervision in the eurozone.

As a result of the purchasing program, the ECB’s balance sheet has grown significantly in recent years, thus becoming an effective monetary stimulus tool in an environment in which interest entered negative territory.

Along with the announcement of the end of QE, the ECB put the following development on the radar: interest rate hikes to start no earlier than summer 2019.  This surprised the markets, not only by setting a timeframe, but also a longer one than expected. This, in turn, has pushed the euro lower and cooled interest-rate expectations. It is safe to say then that the prudence shown in withdrawing stimuli has avoided disrupting the markets, and with that minimized risks.

The ECB is moving toward policy normalization in which the negative interest environment will disappear, allowing the European financial markets to operate in a more “normal” climate. This is good news because keeping interest rates at negative levels in unusual circumstances, prolonged over time, can adversely impact both families and businesses, as well as financial stability.

Nonetheless, we should not forget that a change to monetary policy in Europe occurs in the context of an international landscape of growing uncertainty, resulting from the escalation of trade tensions between the U.S. and China, and to a lesser degree between the U.S. and the European Union. The ECB is facing this challenge with prudence and clear communication.

José Manuel González-Páramo is BBVA Executive Member of the Board, Head of Global Economics, Regulation and Public Affairs

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