MNI POLICY: ECB policy to "remain predictable," Praet says

By Luke Heighton

     FRANKFURT (MNI) - Eurozone monetary policy will remain predictable and

proceed at a gradual pace following a rotation away from unconventional measures

such as asset purchases towards forward guidance, the European Central Bank's

chief economist said Tuesday.

     June's ECB Governing Council meeting sent an "important signal of a

normalisation of our policy instruments" and the "likely future evolution" of

forward guidance through the summer of 2019, Peter Praet said, while enhanced

forward guidance "remains an effective firewall to insulate the euro area from

unwarranted tightening pressures originating elsewhere".

     Here are the key points from the speech in London:

     -- The ECB's reinvestment policy "implies that the bonds we have purchased

will remain on our balance sheet for an extended period of time after the end of

net purchases ... If the central bank wants to exert downward pressures on

long-term interest rates, then it can absorb duration risk from the market by

purchasing securities with a relatively longer maturity. This frees up more

risk-bearing capacity for investors, which they can re-allocate towards other

types of risk, including investment in productive capacity. For a central bank

to set this mechanism in motion, it needs to hold a large stock of long-dated

securities embodying duration risk".

     -- The ECB's reinvestment policy will also contribute to maintaining

favourable liquidity conditions "for an extended period of time". "Of course,

our portfolio - even if kept constant - will tend to lose duration over time, as

the securities held gradually mature. At some point, this passive loss of

duration will begin to exert increasing upward pressures on the term premia.

Over time, this gradual process will tend to steepen the yield curve, with our

forward guidance on policy rates keeping the front end of the curve

well-anchored", Praet said.

     -- Surveys of market participants' expectations regarding the most likely

date for a first rate increase indicate that the "at least through the summer of

2019" formulation has been solidly internalised by market participants, Praet

said. Looking ahead, "the rotation implies that our key policy rates and forward

guidance about their evolution will become an anchor for monetary policy as the

end of our net asset purchases is nearing". ECB communications "and the rate

path itself, will be calibrated to ensure that inflation remains on a sustained

adjustment path."

     -- While the ECB's APP portfolio will continue to exert downward pressure

on euro area long-term interest rates, "other factors such as economic

fundamentals and the creditworthiness of issuers, as assessed by market

participants, remain key determinants of the levels of bond yields and spreads",

Praet cautioned.

     -- The underlying strength of the euro area economy continues to support

the ECB's confidence that the sustained convergence of inflation will proceed as

desired. However, significant monetary policy stimulus is still needed to

support the build-up of domestic price pressures and headline inflation

developments over the medium term.

--MNI Frankfurt Bureau; +49-69-720-146; email: luke.heighton@marketnews.com

--MNI London Bureau; +44208-865-3829; email: Jason.Webb@marketnews.com

[TOPICS: M$E$$$,M$X$$$,M$$EC$]