ECB announces the end of asset purchases

On 14 June 2018, the European Central Bank announced that it would end its bond-buying programme at the end of the year and that it would keep interest rates unchanged at least until summer 2019. The day before, the US Federal Reserve had raised its own rates again. Two major central banks, two different messages, within hours of each other and with consequences for anyone with debts or investments.

The announcement was important because it set a date for the end of an exceptional phase of European monetary policy. For years, bond purchases had sustained very low financing costs across the euro area. Knowing that they would end, and when, allowed markets, companies and families to prepare in advance rather than find out by surprise. That clarity is, in itself, a form of monetary policy. When the central bank explains what it will do, it reduces uncertainty and eases planning for those who depend on its decisions.

What the bond purchases were

With its purchase programme, the ECB bought debt on the markets to keep financing costs low and stimulate the economy. Announcing its end was a step towards normalising monetary policy, albeit gradually and with notice.

When a central bank buys bonds, it increases demand for those securities and, in doing so, reduces what investors require in order to buy them. The effect passes through to mortgages, business loans and debt issues. Withdrawing that demand abruptly could disturb the markets, which is why the decision was announced months ahead with a clear timetable, without each step implying an automatic rise in rates. Gradualism is thus an essential part of the message.

Two central banks, two paces

The Fed in the United States had raised rates again the day before, while the ECB committed to keeping its own unchanged at least until summer 2019. Each central bank acts according to the situation of its economy, and that divergence influences currencies, markets and financing costs.

For anyone operating internationally, those differences matter. When rates rise more in one economy than in another, the currency and the cost of credit move differently, and those who receive or pay in dollars, or hold debts in that currency, feel the effect. Following what both central banks say is a simple way of understanding where money is heading in each region. There is no need to predict their moves; it is enough to know the general direction in order not to be caught by surprise.

What it means for borrowers

Stable rates in the euro area gave visibility in the short term, but they were not an indefinite guarantee. Reviewing the structure of debt — how much is fixed-rate and how much variable — and simulating the effect of higher rates helps to decide whether it is worth fixing terms while the environment is favourable.

A good exercise is to calculate how much the monthly instalment on loans linked to a variable rate would rise if rates increased significantly, and to check whether the company’s or the family’s budget could absorb it comfortably. With those numbers in hand, the conversation with the bank or a financial adviser becomes much more concrete, and alternatives, such as fixing part of the rate, are easier to compare. It is also worth asking what fees and conditions switching from a variable to a fixed rate would involve, because it does not always pay off.

Monetary policy announced in advance allows time to prepare; it is wise to use that margin.

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