EU: On Thursday, the European Central Bank is almost set to reduce assistance even more while promising to keep borrowing prices at historically low levels, keeping to its long-held belief that frighteningly high inflation will subside on its own.
With the euro zone’s economy having recovered to pre-pandemic levels, pressure is increasing on the bank to follow its global counterparts, particularly the Federal Reserve of the United States, in closing the money taps. find out more
However, officials are concerned that taking too many steps back could undo years of progress to revive previously anaemic inflation.
The ECB’s quandary is characterised by an extraordinarily unclear outlook, which may lead rate-setters to postpone many of their major decisions until the new year, leaving policy extremely flexible with few promises.
The Fed’s announcement on Wednesday that it will halt its pandemic-era bond purchases in March and increase rates three times next year complicates things even more for the ECB, since the world’s two largest central banks are now moving in opposite directions, which has previously caused market instability. find out more
The ECB’s compromise is expected to be clarity on its policy framework in 2022, with specifics filling in as policymakers gain confidence that inflation, which is currently running at more than double the bank’s goal level of 2%, will fall fast in 2022.
Bond purchases under the 1.85 trillion euro Pandemic Emergency Purchase Program are expected to be decreased next quarter before being phased out at the end of March. However, a long-running Asset Purchase Program will be expanded to compensate for some of the lost stimulus.
Nonetheless, according to a Reuters poll of analysts, overall purchases could be kept at around 40 billion euros per month, less than half their current level.
Because new government debt issuance is likely to decline, the ECB will continue to hoover up the majority of new debt, keeping borrowing costs near record lows.
The ECB is also expected to announce that it would continue to buy bonds throughout the year in an effort to maintain rates low and rule out a rate hike in 2022.
The policy decision is expected at 1245 GMT, followed by a press briefing by ECB President Christine Lagarde at 1330 GMT.
Beyond that, there are a slew of possibilities.
The difficulty is that, while the ECB expects inflation to return to target in 2023 and remain there in 2024, a number of officials are sceptical of this narrative, warning that high price growth, even if caused by one-offs, could become entrenched.
“Given the many moving elements, accurate calibration of measures is nearly impossible to get 100 percent correct – and the ECB has surprised us many times with new and imaginative thinking,” said Piet Haines Christiansen, economist at Danske Bank.
“We expect the ECB will seek to maintain flexibility, but that comes at the cost of a strong forward guidance.”
The most likely scenario is that the ECB approves a bond purchase quota or “envelope” for 2022, with the caveat that not all of it must be spent.
The bank will subsequently assess the actual volumes on a regular basis and establish purchase targets only for short periods of time, as it has done in recent months.
The biggest danger is that investors begin to sell bonds from the EU’s troubled periphery, raising the borrowing costs for governments there.
Over the last two months, the margin between German and Italian debt has progressively increased, now standing at roughly 129 basis points, a healthy level but up from around 90 basis points earlier this year.
To reduce the risk of fragmentation, the ECB might say that the roughly 100 billion euros remaining in the emergency programme may be utilised in the event of market volatility, and that cash from expiring bonds could be used flexibly, allowing it to spend more in stressed markets.
In a letter to clients, Berenberg wrote, “Rarely has the backdrop for a big ECB decision been as uncomfortable and as unknown as it is now.”