ECB Tapering Talk Precedes QE Launch

The European Central Bank's newest monetary policy tool is already starting to ignite conversations about its conclusion even before the Bank has purchased the first government bonds under its expanded asset purchase programme.

The ECB is set to begin buying government bonds later this month in a programme of quantitative easing that will add more than E60 billion into the Eurozone economy in the hope of stoking inflation and supporting a sustained economic recovery.

While few details have been articulated by the Bank so far, firm economic data and a surprising pivot in currency area inflation prospects has already elicited talk among some analysts that QE could be curtailed before its soft September 2016 deadline.

Eurozone HICP remains mired in negative territory for the third consecutive month, but disinflation improved to an annual pace of -0.3% in February, Eurostat said earlier this week, beating MNI's median forecast of -0.5% as all non-energy related sub-sectors recorded price increases.

Retail sales in both German and the Eurozone surged in January, according to recent data, the former recording the biggest monthly increase in seven years as falling energy prices boosted some of the strongest consumer demand.

Corresponding wage hikes in Germany -- IG Metall, the country's powerful metalworkers union which represents 3.7 million employees, has negotiated a 3.4% for members in the southwest of the country -- and the lowest unemployment rates on record bode well for consumer price dynamics in Europe's largest economy. Sentiment data, as well, in the form of readings from both the Ifo and ZEW Institutes, point to firmer economic prospects and buoyant domestic demand.

The ECB's benchmark gauge of inflation expectations, the so-called 5y/5y forward rate, is also reacting in kind, rising to 1.6575% Wednesday, one of highest readings of the year and a well-placed Eurosystem source told MNI earlier this week that Bank forecasts are likely to show that staff economists expect inflation to return to target by 2017 when the first estimate for that year is published Thursday - just a few months beyond the September 2016 QE deadline signaled by ECB President Mario Draghi in January.

It may seem absurd to discuss the conclusion of QE before a single government bond has been purchased, but it's equally worth remembering that the controversial programme was pushed through the Governing Council against the expressed wishes of some heavyweight members, including Bundesbank President Jens Weidmann, who warned that improving economic data would negate the need to artificially suppress government bond yields and add to Eurosystem risks.

The modalities of the present QE plan have also been questioned, with some wondering if the E60 billion aim is achievable in a market where banks have a relatively low (in historic terms) ratio of sovereign bonds to total assets against increasingly strict regulations with respect to capitalization.

Furthermore, a full implementation of the E60 billion QE target could take out as much as half of the expected 2016 gross issuance of all Eurozone governments next year, according to some calculations, a condition which could raise legal issues given the European Court of Justice's opinion that the ECB's OMT programme mustn't interfere with pricing in the primary debt market.

Should inflation begin its sustained rise towards the Bank's 'close to but below' 2% target next year in the wake of a modest economic recovery and a rebound in global crude prices, the myriad issues the Bank faces with its QE programme may give the Council enough reason to slow the pace of monthly purchases in order to demonstrate the "symmetrical" nature of its consumer price vigilance.

All of this discussion, however, hasn't influenced QE's market impact: bond yields around the Eurozone continue to test record lows and the European Stability Mechanism, the region's permanent bailout fund, may be the first 'SSA' issuer to sell a benchmark bond with a negative yield when it prices its latest offer next week.