Ideally, the ECB would commit to maintaining a steady and moderate pace of purchases in its current program, even as it raises rates.
The ECB could announce this week the solemn end of its 3 trillion euro bond purchase program. That will push up government bond yields, which have already risen after other central banks have started raising rates. This will once again raise the risk of fragmentation within the euro zone. That’s partly because of the ECB’s plan to raise its official rate in July. By making the hike conditional on the end of bond purchases, it can tighten its policy even as financing conditions in peripheral states worsen.
The situation is not alarming for now. Bond yields are rising across the region. But the Italians at 10 years yield 2 points more than the Germans, the highest level in two years.
The ECB will continue to buy some bonds. Lagarde may reiterate that proceeds from maturing securities purchased under quantitative easing will be reinvested, implying $240 billion in purchases in the coming year. But that will only keep the balance at its current size.
For this reason, the most dove members of the governing council are pressing to announce a new tool. But hardliners can find it difficult to agree on when to intervene and with what force. Buying the bonds of a particular country will anger critics who insist that debt-ridden governments should look after themselves. It is much more controversial than the current program, in which the purchases are divided according to the participation in the ECB’s capital.
So Lagarde can remain vague about the terms of any new show. That may simply encourage markets to test their resolve. Ideally, the ECB would explicitly state that bond buying is a normal monetary policy tool, and commit to maintaining a steady and moderate pace of purchases in its current program, even as it raises rates. The risk is that a premature exit triggers unnecessary stress on the markets.
