News that the European Central Bank (ECB) will begin tapering by halving its bond purchasing programme from next year has been met with a muted reaction by market. 
Central banks around the world brought in quantitative easing (QE) programmes in the wake of the global financial crisis to help shore up banks and stimulate growth.
The ECB’s programme began in 2015 but economists have been anticipating tapering for some time as the European economy continues to improve.
From January 2018 monthly asset purchases by the bank will fall from €60bn to €30bn with the new rate set to remain in place until the end of September, if not longer.
However, the ECB did not rule out increasing the programme if the economic outlook becomes less favourable or if it fails to move towards the targeted rate of inflation.
The central bank also announced that proceeds from maturing securities will be reinvested after the programme finishes, contributing to “favourable liquidity conditions and to an appropriate monetary policy stance”.
Mario Draghi, president of the ECB (pictured), said the changes reflected the central bank’s growing confidence in the gradual convergence of inflation rates towards the inflation target of 2 per cent.
He said: “This continued monetary support is provided by the additional net asset purchases, by the sizeable stock of acquired assets and the forthcoming reinvestments, and by our forward guidance on interest rates.”
GDP growth, per cent change over previous quarter
Source: Eurostat
Tapering comes as the outlook for the eurozone economy has shown increasing signs of improvement, as the chart above shows.
Anna Stupnytska, global economist at Fidelity International, said: “The euro area recovery is certainly becoming more entrenched, with broad-based growth across countries and sectors of the economy.
“The euro strength seen so far is unlikely to derail the growth story or pave way for a return of deflationary worries.”
She added: “At the same time, however, given the remaining slack in the labour market, inflation is far below the target and is likely to rise only at a very sluggish pace.”
The move was largely anticipated by the market, with senior officials such as Draghi hinting at the announced changes in the weeks leading up to October’s meeting.
“The ECB’s policy adjustments were pretty much bang in line with market expectations; no surprise there given the various speeches and leaks from ECB sources in the run up to this meeting,” said Andrew Mulliner, fixed income portfolio manager at Janus Henderson.
“At the margins the ECB retains its dovish tilt; keeping the open-ended nature of the QE programme and referencing their ability to do more should the outlook disappoint, something that some in the market had thought might be dropped.”
Annual inflation in the euro area and the EU
Source: Eurostat
Charlie Diebel, head of rates at Aviva Investors, said while the new programme represented just half of its current commitment, it still represented a further €270bn of liquidity for European fixed income sector.
He said: “The market has rallied in fixed income and the euro has sold off as there was a hawkish bias to expectations going into the announcement.
“The fact that the ECB will continue to reinvest proceeds for some time after QE ends, adds to the dovish read and in turn should be supportive for risk assets.”
David Zahn, head of European fixed income at Franklin Templeton Investments, said while tapering would set the central bank on the road to monetary policy normalisation, it was unlikely to be a quick journey.
“The ECB is committed to remaining accommodative for some time and its tapering of bond purchases will be slow and steady,” he said.
However, Adrian Hilton, head of global rates and currency at Columbia Threadneedle Investments, said there could be more surprises after Draghi revealed a clash of opinions over how long the programme should last.
“For us, Draghi’s admission that certain council members opposed the open-endedness of the asset purchase programme is a sign that there is likely to be far more disagreement over the future path of policy during 2018, especially if the dynamics of growth remain robust,” he said.
“As the output gap closes, the ECB policy stance will begin to look excessively accommodative and we expect the dissenting voices to grow louder.”
Interest rates seem likely to stay lower for longer, with the ECB governing council signalling that it expects interest rates to remain at present levels for “an extended period of time, and well past the horizon of the net asset purchases”.
Zahn said the rates were likely to remain low until 2020, while Hermes Investment Management senior economist Silvia Dall’Angelo said a hike could happen around mid-2019 “at the earliest”.
However, with markets having largely anticipated the reduction of the ECB’s asset purchase programme, there are few opportunities for investors to take advantage of.
Viktor Nossek, director of research for exchange-traded fund provider WisdomTree in Europe, said there were some trades that investors might consider.
“Investors in Europe should consider hedging their fixed income exposures, now that the ECB is cutting back asset purchases from the start of 2018,” he explained.
“German bunds could now be in the firing line, as the cut back could spark a taper tantrum in Europe,” said Nossek. “Now that the ECB has signalled the recovery is more self-sustaining, bunds could follow the same path as US treasuries did in 2013.
“Therefore now could be the time for investors to consider shorting these bunds, especially with yields so close to record lows.”
Franklin Templeton’s Zahn said while there could be sustained upward pressure on yields overall given the focus of the programme, there might still be some volatility in European government bond yields and investment opportunities.
“The story in Europe is never quiet and over the next 12-18 months, we think ongoing volatility will continue to present opportunities for managers to capture opportunistic pockets of yield,” he added.