Exclusive-ECB policymakers urge review of QE consequences

By Balazs Koranyi and Francesco Canepa

SINTRA, Portugal (Reuters) -Some European Central Bank policymakers are urging a review of the aggressive monetary stimulus policies the ECB employed for nearly a decade to tackle low inflation, judging they may have done more harm than good, sources told Reuters.

Their calls represent one of the most direct challenges yet to the logic that underpinned quantitative easing (QE) - the massive bond purchases that were the ECB's flagship policy for nearly a decade under Mario Draghi.

The U.S. Federal Reserve was the first of a number of central banks to use QE during the global financial crisis, dusting off a measure from the Great Depression of 1929 to stimulate economies and avert the risk of deflation.

Six ECB policymakers said they want to debate and possibly change a clause in the ECB's strategy statement that calls for "especially forceful or persistent" action - code for QE - when interest rates are at rock bottom. All spoke on condition of anonymity because the discussion was private and preliminary.

Such a debate is expected to take place in a long-planned ECB strategy review that is about to kick off, concluding some time next year.

"We bought trillions and trillions of euros of assets and still didn't get inflation back to target," one of the sources said on the sidelines of the ECB's annual Forum on Central Banking in Sintra, Portugal.

"Years after the end of this stimulus, we are still sitting on more than 3 trillion euros of excess liquidity, so that policy response tied our hands for years."

An ECB spokesman declined to comment.

The euro zone's central bank bought some 5 trillion euros ($5.4 trillion) of debt - mostly government bonds - over nearly a decade before the COVID pandemic, and also gave banks interest-free loans.

While the issue seems distant now that inflation is above target and interest rates high, recent comments by the Bank for International Settlements, a global umbrella group for central banks, have reignited debate about QE's effectiveness.

"The BIS generated a quite a storm this weekend and I think they are right in that we need to reassess how we use some of our tools," one of the ECB sources said.

The BIS argued that prolonged use of ultra-easy monetary policy generates diminishing returns and creates unwelcome side-effects, including excessive risk-taking by firms, households and governments.

"These limitations were not fully appreciated at the time the measures were first introduced," it said in its flagship publication.

Instead, the sources, mostly from the ECB's conservative camp, argued central banks could simply live with modest inflation undershoots because the cost is relatively small compared to the stimulus effort - as in Switzerland, where the central bank aims to keep inflation in a zero to 2% band.

Other policymakers defended the ECB's debt purchases, saying it was the correct response given the information available at the time and letting inflation run too low for too long would have permanently damaged the economy.

The ECB has fiercely defended QE in its research.

A paper by senior staff found QE, combined with a commitment to negative interest rates, had boosted growth and inflation, while keeping unemployment lower than it would have been.

Then-ECB chief Draghi credited the "favourable financing conditions" engineered by the central bank for creating 4.5 million jobs in 2015-17.

EXCESS LIQUIDITY

The ECB ended its QE and TLTRO bank lending programmes in 2022 and has been running down its bond holdings since 2023.

But 3 trillion euros of excess liquidity remains in the system even after a string of sharp interest rate hikes and could still take five years to decline to desired levels.

All the six ECB policymakers who spoke to Reuters agreed that asset purchases were the right tool in case of a shock such as the pandemic, for which the central bank launched a separate bond-buying scheme.

But they said QE should not be used with such intensity and for so long to respond to long-term issues, particularly structural deficiencies that should be tackled by governments rather than central banks.

All six sources said the ECB should maintain a symmetric approach to its 2% target, but some argued that it should remove its commitment to an especially forceful or persistent response to low prices. Others want a clear acknowledgement that prolonged asset buys are not an appropriate policy instrument.

That chimes with recent comments by ECB board member Isabel Schnabel, who said QE had helped stabilise stressed financial markets but had costs such as causing central bank losses, interfering with market functioning and boosting inequality.

Schnabel advocated "more targeted and parsimonious" bond buys, like the Bank of England's intervention amid market turmoil following September 2022's British mini-budget.

Separately, Irish central bank chief Gabriel Makhlouf questioned the impact of quantitative easing on economic equality and advocated a deeper look at it when the ECB reviews its strategy.

"I think QE played a positive role in supporting employment during very low rates, but I'm not sure whether their impact on asset prices, wealth and inequality, whether we understand well enough to be able to say that overall this was a net positive," Makhlouf said in Sintra.

The Federal Reserve has been asking similar questions: U.S. central bankers generally agree that QE is a good tool for stabilising markets but many of them also feel the Fed's COVID-era assets purchases went on too long.

($1 = 0.9298 euros)

(Additional reporting by Howard Schneider in Washington; Editing by Catherine Evans)