The European Central Bank (ECB) has announced that it will extend its programme of quantitative easing until the end of 2017, although it will reduce the size of the programme.
The euro surged briefly on the extension before plunging to wipe out all of the day's gains and fall by as much as 1.1 per cent.
European government bond yields soared in response to the tapering implied in the announcement, with German 10-year yields reaching their highest point since January. However, after ECB president Mario Draghi emphasised the "sustained presence" of the ECB in the market yields fell back to reverse almost all of their gains.
"There is no question about tapering"
Draghi denied that it was the start of tapering. At a press conference he said: "There is no question about tapering. Tapering has not been discussed today."
The ECB will buy €60bn of bonds each month from March 2017 until the end of December 2017.
The move sent a mixed message to markets. Chris Williams, chief business economist at IHS Markit, said: "The move seems a reasonable compromise: the stimulus will provide a further boost the region’s recovery in the face of elevated levels of political uncertainty but also recognises the encouraging recent economic data flow and the growing constraint on the amount of assets eligible for purchase."
The current round of quantitative easing had been due to finish in March 2017. Since March the Bank has been buying bonds worth €80bn each month, an increase from the €60bn monthly purchases which started in March 2015.
A broader QE net
The Bank also indicated that it has changed the parameters of the programme. Bonds with yields below -0.4 per cent will now be eligible for purchase, along with bonds with a maturity of less than two years. The Bank had been struggling to find enough eligible sovereign bonds under the constraint.
The beginning of tapering surprised analysts, who had been expecting little in the way of a change in policy.
"The ECB may have pulled off the biggest central bank shock of the year, considering the Fed’s rate hike next week is already 100% priced in by the market," said Kathleen Brooks, research director at City Index.
A dovish taper
Naeem Aslam, chief market analyst at ThinkMarkets, said: "The breath taking day has just turned into an exciting day. It was the decision of the ECB which has changed the colour for the trading day. The ECB will change the flight path to its more conventional stance, but today is surely not that day."
"The bank has extended its quantitative easing program until December which is more than what the market was expecting. However, the bank is going to reduce their fire power after March and will only be purchasing 60 billion. So you can say that the bank is tapering in a more dovish way."
Investors had broadly expected an extension of the programme, after the ECB held fire at its October meeting.
Quantitative easing – officially known as the asset purchase programme – refers to the process of buying government bonds from private-sector banks to free up their balance sheet for lending to businesses.
This stimulus programme is intended to boost the Eurozone economy. Inflation has remained stubbornly low since the Eurozone crisis, as ultra-low interest rates have failed stimulate the economy.