ECB’s Schnabel Downplays Expectations; Markets Can’t Dictate Policy

21 July 2020

By David Barwick – FRANKFURT (EconoStream) – European Central Bank Board member Isabel Schnabel on Tuesday played down expectations of further ECB action and rejected the idea of allowing monetary policy to be dictated by financial markets.

In an interview with Spanish daily Expansión, Schnabel, according to a transcript provided by the ECB, indicated that the ECB would react with flexibility even if inflation were to increase.

Asked whether the ECB had done enough, Schnabel emphasized the central bank’s data-driven approach that had led it to act in June. Although there have been ‘upside surprises’, she allowed, these ‘are not sufficient to make us change course from our baseline scenario’ calling for real GDP to decline 8.7% this year.

There was no reason at the July monetary policy meeting to revise the previous decision, she said, adding that ‘we have certainly seen an improvement in the financial data’ and that markets ‘have calmed down quite a bit’ even if ‘conditions are still somewhat tighter’ than pre-pandemic.

Effectively asking financial markets yet more explicitly to sit tight for the moment, she observed that the full effect of ECB policy action ‘does not happen overnight’ and that fiscal policy has its own important contribution to make.

Schnabel cautioned against making too much of the slower pace of purchases recently under the ECB’s Pandemic Emergency Purchase Programme (PEPP), arguing that seasonality can also influence monthly volume.

Cumulative net purchases of the ECB under the PEPP as of last Friday were €403.75 billion, not quite €49 billion more than its holdings as of end-June. That compares to average monthly purchases in the three previous months of more than €113 billion. At last week’s press conference, ECB President Christine Lagarde said the deceleration reflected the fact that ‘financial markets have been more stable, because the fragmentation risk has really significantly been reduced.’

Schnabel reiterated Lagarde’s contention that the full PEPP envelope of €1.35 trillion was likely to be deployed in the ECB’s baseline scenario. Though ‘upside or downside surprises are both possible in a situation with so much uncertainty’, she said, risks overall are to the downside.

‘It would be very good news if we were to see such an improvement in the outlook that we could use less of the envelope’, she added. ‘That’s not the case for the time being, so the size of the current envelope remains appropriate.’

Monetary authorities continue to dispose of an adequate arsenal to address any scenarios, Schnabel said, and ‘can adjust our existing tools or create new tools in the future if necessary.’ However, she made clear, market speculation about additional action won’t drive ECB policy.

‘Whenever we take a new measure, some market participants already predict that we are going to do more’, she said. The ECB is data-driven and it ‘is crucial to avoid a situation in which the markets end up dictating what decisions we take.’

For example, she continued, the PEPP’s scope reflects the current macroeconomic situation and ‘won’t change just because investors are expecting more. What would have to change is the data.’

In the same vein, Schnabel dismissed as ‘clearly exaggerated’ the idea that unsustainable debt on the part of some Eurozone member states effectively obligated the ECB. Noting the debate about fiscal dominance, she insisted that ‘we have shown in the past that we can stop our net asset purchases’ and would do so again ‘[w]hen the time comes’, based on inflation prospects.

A sudden increase in inflation, if one-off, would not affect the ECB’s medium-term decision-making, she said: ‘It has to be something persistent.’ And although the ECB is guided by a desire to restore price stability, ‘we can adjust the speed at which this happens’, she said.

This involves consideration of side effects, she continued. ‘So even if inflation were to increase, we would not raise interest rates immediately if doing so would tip the economy into a recession’, she said. ‘Over the medium term, such a rate hike could be even more damaging to price stability. So we have some flexibility.’

The ECB faces no urgent need to discuss buying debt that has been downgraded to below investment grade, she said, but is alert to the possibility that such downgrades will occur in larger numbers. Purchasing such debt is not fully ruled out, she said, ‘but it’s not on our agenda at the moment.’

Schnabel conceded that ‘in due course’, the ECB would have to decide ‘how, and to what extent’, it would ensure that its purchases of sovereign debt under the PEPP would converge to the key used to calculate national central banks’ respective share of the ECB’s capital. ‘It seems clear that the reinvestment phase can play a role here, but we haven’t decided on this yet’, she said.

The €1.3 trillion take-up by banks at last month’s first allotment of the third series of targeted longer-term refinancing operations (TLTRO III) didn’t fully exhaust banks’ capacity ‘to ask for more liquidity’, Schnabel said. While that probably represented ‘the largest part of the take-up’, upcoming operations could still meet with some demand, she said.