European Central Bank in Frankfurt, Germany. Picture: MARTIN LEISSL/BLOOMBERG
European Central Bank in Frankfurt, Germany. Picture: MARTIN LEISSL/BLOOMBERG

Frankfurt — Louis Harreau of Credit Agricole CIB may have cracked the code for how the European Central Bank (ECB) will end its quantitative easing programme.

It’s contained in a simple equation, which he has dubbed the "new generation" Taylor rule, a reference to a tried-and-tested central bank model for setting interest rates based on how much inflation and growth are deviating from their target rates.

His formula goes like this:

Monthly net injection from the ECB in billions of euros (QE + TLTROs) = 120 x (1.5 — core inflation). TLTROs are targeted longer-term refinancing operations.

How does it work? Harreau observed that before price pressure began to falter in the eurozone in about 2013, the core inflation would average 1.5% a month. So at that level, conventional monetary policy should be enough, he reasons. Harreau then looked closer at three episodes of the ECB’s massive easing programme.

Harreau crunched the numbers and came up with an "A factor" that solves the equation for these three periods: the number 120.

After plugging in his forecast for core inflation, the formula suggests the ECB will reduce its monthly pace of asset purchases to €35bn-€40bn at the beginning of next year, then to €20bn from July and wrap up the programme at the end of 2018.

A classic disclosure obviously applies: past performance is no guarantee of future results. Harreau’s forecast may turn out to be wrong. But he could be on to something.

The eurozone recovery is clearly gathering pace and some policy makers have signalled the decision on how to end the bond buying is getting near. ECB president Mario Draghi said in a speech in Sintra last month that "the central bank can accompany the recovery by adjusting the parameters of its policy instruments — not in order to tighten the policy stance, but to keep it broadly unchanged".

How that will come about is for Draghi and his colleagues to decide. Their next decision is already this Thursday.


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