It has been quite a year for the financial markets and it is far from over yet. Up next, as well as the fallout from the Italian referendum, are two crucial central bank meetings. The European Central Bank will make its key announcement this Thursday, followed by the Federal Reserve Board the following Wednesday.
US interest rates are broadly expected to rise by another 0.25 of a percentage point, the end of a lengthy saga which followed the first rise since the great crisis, announced a year ago. It remains to be seen how the markets react – the rise is long-flagged, but for a generation of traders not used to dealing with rising borrowing costs, this will all be new.
However the dilemma facing the ECB is, possibly, even more acute. The ECB has to find a way to very gradually start withdrawing the monetary stimulus which it has been pumping into the euro zone economy. The ECB buys a massive €80 billion in European bonds – mainly of member state governments – every month, in a programme due to continue until next March.
Stick with programme
It can’t just stop the programme suddenly. And with only tentative signs of recovery and higher inflation – and fears about the fallout from the Italian referendum – it needs to send some signal of an extension of the programme. Speculation is that the programme may continue until next September or December, possibly with a lower monthly bond-buying total.
This is tricky territory. The US bond market took fright when the Fed signalled it was stopping its programme of quantitative easing in 2013 – forcing the Fed to back off for a period in the face of what was dubbed a “ taper tantrum”. The Fed has also had to move very carefully increasing interest rates.
With bond markets already under pressure after Donald Trump's election victory – which has spurred expectations of higher inflation – the ECB will have to choose its words carefully. Complicating everything is the German opposition to the whole bond-buying programme and its wish to finish it as quickly as possible. ECB president Mario Draghi, a master strategist in getting his way in recent years, faces another tricky task.
