The ECB has provided record monetary support for the euro zone since the start of the pandemic. But economic growth in the bloc is now solid, unemployment is falling and inflation is on the rise, setting the stage for a debate that will chart the bank’s course for years to come.
On the surface, it looks simple: the economy is back on track and even if the pandemic persists, Europe has learned to live with it, so the crisis — the ECB’s casus belli — is over.
But some say this is a crisis like no other and a hasty cut in support risks undoing the bank’s unprecedented work when the pandemic is far from over.
Furthermore, the ECB has undershot its inflation target for almost a decade, so investors are already doubting its commitment, making the withdrawal of support especially risky.
The first decision, a reduction in bond purchases, is already due on Thursday and may be relatively easy, masking deeper divisions.
Indeed, conservative policymakers joined by centrist French central bank chief Francois Villeroy de Galhau have pushed to include such a cut on the agenda, generating only modest market reaction as yields rose only a touch from multi-month lows.
The fact that no policy doves — jargon for those who favour easy monetary policy — have pushed back in public is likely a hint that the move in itself will be uncontroversial.
Analysts polled by Reuters see purchases under the ECB’s Pandemic Emergency Purchase Programme (PEPP) falling possibly as low as 60 billion euros a month from the current 80 billion before a further fall early next year and the scheme’s end in March.
“We expect the ECB to announce a reduction of PEPP purchases for the fourth quarter because the macro backdrop is much improved,” Barclays economists wrote in a note. “Growth and inflation forecasts will be revised upward.”
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But the message that accompanies the move may be more crucial. Hawks who favour tight monetary policy will see it as the first step towards the exit while doves, who are in the majority on the 25-member Governing Council, will sell it as just an incremental move and not the start of tapering.
ECB chief economist Philip Lane has already said that any decision in September will be marginal as the bank will continue to provide copious support as the real discussion on unwinding the crisis-fighting measures is due later.
“We expect (ECB chief Christine) Lagarde to try and convince markets that reduced PEPP flows would not represent a tapering signal but rather a technical adjustment,” UniCredit economist Marco Valli said.
Doves are also expected to emphasize that even if the emergency measures end next March, other tools will be ramped up, given a weak inflation outlook and the fact that the ECB would rather err on the side of caution with any further move.
“It is going to be gradual, communicated well in advance and still characterised by a fundamentally asymmetric bias to risks: the bar to accelerate the process is set rather high, while the bar to pause it is conversely unusually low,” BNP Paribas said in a note.
The speed with which the ECB reduces its support will be a hotly debated issue, however, because it has wider implications for the rules that govern more conventional, non-emergency bond buys, the bank’s primary tool beyond the pandemic.
The longer it stays in the market to buy up debt and hold down yields, the closer it will be to breaching some of its self-imposed rules, which are red lines for some policymakers.
Especially important is a rule that forbids the ECB from buying up more than a third of any country’s debt, a limit it is nearing in several key countries.
Other rules, like buying pre-set volumes of assets and in proportion to the size of each country’s economy are also likely to be tested, irking conservatives who have fought to keep these in place.
The ECB could simply change some of these rules, but policy hawks argue that this sort of flexibility should be reserved for crises and that Europe is now returning to more normal times so the ECB must also step back.
“The first P in PEPP stands for pandemic, not permanent, and for a good reason,” Bundesbank President Jens Weidmann said last week.
