The ECBs Big Surprise!

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What's going on?

In a move that surprised most investors, the European Central Bank (ECB) announced on Thursday that it would begin decreasing the amount of government bonds it buys each month (tweet this). Thats way more important than it sounds!

What does this mean?

Over the last few years, the ECB has been trying to spur economic activity by directly buying government bonds. Higher prices for bonds cause interest rates to go down (click here for an explanation not to be confused with a central banks target interest rate) so in theory, the more bonds the ECB buys, the lower their interest rates go. These lower interest rates spur growth by making it cheaper for people and companies to borrow (since loan rates are essentially based on these broader interest rates), and then spend, money. The opposite also holds true: by purchasing fewer bonds each month in the future, the ECB wont be pushing interest rates down so much.

Why should I care?

For markets: The ECB didnt hit the brakes, they just took their foot off the gas pedal a bit so its not as bad for bonds as it sounds.
Thursdays move is only a very moderate pullback of support from the ECB. Also, the ECB made clear that it would again step up bond purchases if conditions required it (e.g. if the economy worsened). The question now is what move the ECB will make next will they reduce bond purchases further later next year?


The bigger picture: This shows that its been a decent year for the eurozone economy.
Eurozone economic growth remains well below its historical average, but relative to recent years, economic growth has picked up. The moderate strength has evidently given the ECB confidence to make its policies a bit less supportive for the first time in years. In the grand scheme of things, its policies remain extremely supportive, but its notable that the ECB feels the economy can handle a little less help. Keep in mind, a central bank has to remove support when its economy is strong enough, so that it can give support when it weakens again.

Originally posted as part of the Finimize daily email.

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