The European Central Bank has extended its quantitative easing policy at least until the end of next September but has reduced its rate of buying from 60 billion euros ($69.6 billion) a month to 30 billion euros. ECB President Mario Draghi said that the program will not end abruptly, indicating that it could be extended again, at a further reduced rate. He also said that if need be, the program could be increased. While this is unlikely given the prospect of continued solid growth and slowly rising inflation, it is a sensible point to help prevent the market pricing in purely one-way risk, helping to subdue market interest rates and to keep the euro softer on the foreign exchange markets than otherwise.
The scaling back of the program reflects the fact that the economy is booming and no longer needs such aggressive accommodation. The extension reflects the other side of the coin, that achieving the ECB's target of inflation remains a long way off.
Remember that the ECB has a single target, inflation, whereas the U.S. Federal Reserve has a dual mandate, price stability and maximum employment. In the current circumstances of good growth and narrowing output gaps, this makes a significant difference to how the ECB and Fed operate. Since the ECB has a 100% weight on inflation, but the Fed only 50%, it makes sense for the ECB to wait longer and reduce tightening more slowly than the Fed did: This is happening. We can see this in the fact that the first reduction in the ECB's rate of purchase came in March this year (80 billion euros a month to 60 billion). If QE does end in September, tapering will have taken 18 months, whereas the Fed's took eight. This signals a much greater reluctance to hike rates than the Fed showed -- because in our view the earliest that the first hike can come is six months after the end of QE. In the Fed's case it was 14 months afterward.
The language accompanying the ECB's decision was decidedly dovish -- no one wants to suggest this recalibration signals a reorientation of the monetary policy stance, as appeared to occur with the 2013 U.S. taper tantrum. In fact, Draghi denies the ECB's move is tapering, a term that suggests an end to QE. Rather, the ECB portrays this as an open-ended recalibration. If QE were to end next September, the first rate hike would likely not be before March 2019. If QE were extended further, it would be even later in the year. Mr Draghi's eight-year term as president expires on Oct. 31, 2019, and he cannot be reappointed. The ECB guidance can be interpreted as suggesting there is a very good chance that the inaugural rate hike will be left to Draghi's successor.
Compared with the Fed, the ECB is being much more patient and is sounding more dovish than the Fed did at the same stage of the monetary cycle. Tapering in the eurozone may not be completed until the output gap is virtually closed, whereas in the U.S. it came far earlier. Moreover, Draghi does not talk about "normalization" as the Fed often has done, and there are no "dots" suggesting a keenness to raise rates. Everything about the recent announcement and strategy says the ECB will not raise rates until inflation is clearly on a solid upward trajectory. In contrast, the Fed seems to be putting little weight on below-target inflation in signaling that a December rate hike is a real possibility.
The altogether more dovish approach of the ECB gives it an increased chance of hitting its inflation target because it will encourage inflation expectations to rise. In contrast, the Fed's obvious desire to raise rates has damped inflation expectations, impeding its achievement of its inflation target. Draghi is doing an excellent job by committing to create inflation through only slow reductions in accommodation despite a boom.
Paul Mortimer-Lee is chief market economist and head of U.S. economics at BNP Paribas in New York.