The ECB halves its purchases

On 26 October 2017 the European Central Bank announced that it would halve its monthly debt purchases from January 2018, a first step towards the end of stimulus. The decision confirmed that eurozone monetary policy was beginning, very gradually, a path of normalisation after years of exceptional measures applied to sustain the economy after the crisis. For companies and families, the change in the monetary cycle matters as much as any tax or regulatory change.

It was expected news, and markets received it calmly, but its medium-term meaning is important. The cheap money that had eased the financing of states, companies and families for so long was ceasing to be something that could be taken for granted. For anyone who has built plans on exceptionally favourable credit conditions, it is a good moment to go back over the assumptions. What yesterday was a reasonable assumption may tomorrow become a source of financial strain.

What the ECB was buying

To stimulate the economy after the crisis, the European Central Bank bought government and corporate bonds on a massive scale. Those purchases kept interest rates low and made credit easier to obtain for states, companies and families. By buying bonds, the central bank increases demand for them and thus their price, which lowers the return investors demand and therefore the cost of borrowing.

This mechanism was especially important for the most indebted countries, which benefited from more favourable financing conditions than they would have obtained without that support. But it is an extraordinary mechanism, conceived for exceptional circumstances, and its gradual withdrawal is the logical consequence of the economy regaining its pulse. The challenge lies in doing it without causing shocks. Hence the central bank communicates its steps with so much notice and detail.

What changes with the reduction

Cutting purchases does not mean raising rates, but it does signal that the extraordinary support will taper off. For heavily indebted countries such as Spain, and for those with variable-rate financing, it is a sign that cheap money will not last for ever. Official rates remained low, and the central bank had insisted that any rise would come later, but the direction of change was clear.

The consequences are not immediate, but they will be felt in the cost of new debt issues, in financing conditions and, in time, in the instalments of variable-rate loans. For the banking sector, the change also means a transformation of the environment in which it operates. Those who understand that trajectory in advance will have more room to adapt their financial decisions.

Preparing for higher rates

Companies with debt and families with variable-rate mortgages would do well to measure how a rate rise would affect their payments and to assess, with their bank or an adviser, whether to fix terms or pay down debt. A simple exercise is to calculate how much the instalment would change if the reference rate rose by one or two points and to check whether the budget can bear it. If the instalment becomes uncomfortable under that assumption, it is a signal to act in good time.

Anticipating is always cheaper than reacting. If there are surplus funds, it is worth considering whether it is preferable to reduce the dearest debt; if new financing is needed, it may be better to arrange it before conditions worsen. Each situation is different and should be analysed calmly, with the help of an adviser. This text is general information and not investment advice.

The end of stimulus tends to be slow, but it comes.

This article is general information. It is not legal, tax or investment advice, and it does not take anyone’s particular circumstances into account.