5 Questions for the ECB Policy Meeting

The Wall Street Journal The Wall Street Journal

Key issues range from the euro’s strength to the central bank’s plans for tapering its bond purchases

FRANKFURT—European Central Bank officials returning from their summer vacations face a crucial question: What to do about their €2.3 trillion ($2.7 trillion) bond-buying program, known as quantitative easing. A false step could roil financial markets and undo the ECB’s good work in reinvigorating the eurozone economy.

Policy makers have been largely silent on the ECB’s plans, heightening the suspense. Investors will listen intently to ECB President Mario Draghi’s news conference on Thursday for clues to the road ahead. Here are some questions the ECB chief might tackle:

How strong is the eurozone economy?

It has rarely been in such good shape. Growth is rapid in swaths of Europe and broadening across the region. Credit markets are strengthening and unemployment, though high, is falling swiftly. “All the economic sentiment indicators, the survey indicators, are either at all-time high or close to that,” Mr. Draghi said in July. That is still true. Only inflation, at 1.5% last month, remains disappointingly weak.

What about the euro?

The strength of the common currency—up nearly 3% against the dollar over the summer—has been the main development since policy makers met on July 20. Some ECB officials were already warning then that the currency might overshoot, according to minutes of the meeting. A stronger euro could weigh on the ECB’s new forecasts for growth and inflation, which are published on Thursday and a crucial input for the bank’s decisions. Downward revisions would make policy makers nervous about reducing their monetary stimulus.

What can the ECB do about the exchange rate?

One easy option would be for Mr. Draghi to talk it down. ECB officials are usually reluctant to discuss financial-market developments, but saying nothing is also risky. Mr. Draghi’s failure to discuss the euro in Jackson Hole, Wyo, led to a fresh surge, as traders took the ECB’s silence as an invitation to buy. The ECB chief might seek to strike a balance, arguing that the exchange rate isn’t a policy goal but warning that a further appreciation could harm the region’s recovery.

Is it too soon to taper?

There are reasons to wait. Inflation is still too weak, and the Federal Reserve has yet to reveal its own policy course, which will affect the euro’s exchange rate. A detailed plan for tapering QE, therefore, seems unlikely now, particularly since investors haven’t been prepared. Still, there are early signs of a pickup in underlying inflation, excluding volatile food and energy prices. Many analysts expect the ECB to send a cautious signal on Thursday that it will gradually reduce QE next year.

How much longer can QE run?

After 2½ years, QE’s self-imposed constraints on assets purchased could start to bite if the program is extended deep into 2018. To avoid any bottlenecks, the ECB could widen the pool of assets it buys, but that would be politically contentious. Mr. Draghi might instead suggest that the ECB can operate more flexibly within the program’s existing rules, by being less rigid about buying bonds in proportion to the size of each economy, for instance.