Investing.com - As investors gear up for the European Central Bank to hold its final monetary policy meeting of 2016 on Thursday amid expectations for an extension of its bond buying program beyond the current March 2017 endpoint, the question turns to how long the extension might be and whether the European monetary authority will adjust the size of purchases from the current €80 billion ($85.9 billion) per month.
52 out of 60 economists surveyed in a recent Reuters’ poll released last week predicted that the ECB would decide to extend the program.
Out of those looking for an extension, opinions differed from three months to “open-ended”, but the majority placed bets on six months to September 2017.
However, five of these experts were forecasting no policy change and another three felt that “tapering”, or scaling back, of the amount would begin.
A question of tapering
IG market strategist Daniel Pingarron believes that the ECB will extend their program, but is among those who also feel that policymakers will reduce the size of their purchases in order to avoid a bursting of the bond market bubble.
Goldman Sachs suggested that the two major questions to be answered in Thursday’s meeting was whether there would be a formal taper decision and, if not, whether ECB president Mario Draghi would hint that one would come soon.
These experts were skeptical of bets of a possible scenario wherein the ECB tapers purchases to a monthly pace of €40 to €50 million and simultaneously extends the program longer, to the first quarter of 2018.
“We think such proposals fail to take account of how skeptical markets have become where the ECB is concerned,” they said in a note to clients.
“After all, the December 2015 meeting and the misfire in March of this year have taught markets to be extremely skeptical as to the ECB's willingness and ability to ease," they explained.
“What’s priced into markets is a fully fledged extension of the program,” BlackRock strategists told The Wall Street Journal. “We think there’s a significant chance the ECB disappoints markets,” they warned.
Analysts at Nomura predicted that the European monetary authority will extend the program by six months without reducing the amount which in turn will likely “put downside pressure on euro area yields and peripheral spreads, while risk sentiment is likely to be supported somewhat too.”
However, they also warned that “an immediate tapering decision or a step toward tapering could slow euro area investors’ foreign bond investment,” with a corresponding downside pressure on EUR/USD.
“A tapering announcement would likely widen peripheral spreads and hurt risk sentiment,” these experts said.
ECB economic projections key for future policy moves
While both Danske Bank and UBS forecast the ECB to extend the program by six months at current levels, they pointed to the updated economic projections from the central bank as a key piece to the puzzle.
Data last week showed that euro zone inflation hit a 31-month high in November, but core inflation, the key measure watched by the ECB, was at just 0.8% for a fourth consecutive month, far below the 2% inflation target.
After being below target for more than three years, Draghi forecast last week that it would return to 2% by 2018 or 2019.
“Lately there has been a lot of speculation on QE tapering, but in our view it is too early to expect an announcement about ending QE,” Danske Bank analysts said.
“Very prominent ECB members including President Draghi have increasingly emphasized the lack of upward pressure on underlying prices, which together with an expected considerable downward revision to the ECB’s core inflation forecast, should convince enough of the ECB members that it is too early to consider an end-of-easing,” they explained.
“While the new staff macroeconomic forecasts for 2017-19 will form an important basis for the decision, we think the members of the ECB Governing Council will have to take an even more comprehensive view, evaluate the broader balance of risks and ask themselves whether the time is ripe for a reduction in monetary stimulus,” UBS said in their own analysis.
These experts do not expect the ECB to taper until “after September 2017, perhaps over the course of one year.”
For the medium-term, although they do not think ECB policy rates will be cut further, they also rule out rate hikes until 2019.
ECB's major issue is a lack of government fiscal effort
With that longer-term perspective in mine, the ECB’s principal problem continues to be the national governments lack of effort to implement fiscal policies that would support growth and remove the need for accommodative monetary policy.
As on many prior occasions, Draghi reiterated this issue last week while claiming that ultra-easy monetary policy has given governments in the region time for reforms. Those efforts need to be stepped up, he said.
“As Draghi recently reminded us, ‘QE is not forever’,” Barclays wrote in a note to clients at the end of November, citing moral hazard and reform complacency as downsides for government debt when warning about the end of easy monetary policy.
“Debt sustainability issues will resurface not only because of higher interest payments but also, critically, because long-term growth prospects are dismal without reforms,” these analysts said. “This could in turn require ‘permanent QE’ to avoid a fiscal crisis,” they warned.