For Some at the ECB, a Question of Staying Ahead of the Curve

26 October 2020

By David Barwick – FRANKFURT (EconoStream) – The European Central Bank’s Governing Council faces a choice at Thursday’s monetary policy meeting that could be uncomfortably stark for some of its members. Though financial markets expect another stand-pat decision, events since September 10 may have fostered the sentiment among some participants that the ECB is in danger of falling behind the curve. A surprise outcome is not excluded.

The euro’s renewed strength, the likelihood of a suboptimal Brexit and the possibility that U.S. elections will plunge the world’s biggest economy into turmoil are all risks the Council vowed last time to monitor closely. On none of these fronts can anything like an all-clear signal be given. But they have all been overshadowed by the apparent materialisation of the single clearest threat: the pandemic.

Back with a vengeance, daily new Covid-19 case numbers in many European countries are a multiple of first-wave highs. The seven-day moving average of positive diagnoses across the six largest economies of the Eurozone stood at 21,984 on September 10; as of Sunday it was at 94,696 and poised to climb further.

The ECB has not made entirely clear at what point the current wave of the pandemic would no longer square with its central scenario. Alarming though they may be, actual case numbers do not directly drive monetary policy, more relevant being the public health policy response to those numbers and how economic agents react. As Governing Council members of various stripes have noted, the ECB’s baseline scenario allows for some resurgence.

Still, what the region faces today seems substantially worse than what was dismissed as ‘a certain flare-up’ on October 8 by Bundesbank President Jens Weidmann and as ‘some pick-up in the virus’ three days later by Chief Economist Philip Lane. The latter offered guidance of sorts at the time: ‘If it’s shown that you can control the virus with serious but not universal restrictions, then that’s more or less in line with our baseline’, he said.

As France extends an overnight curfew to dozens more areas of the country, large swathes of Italy are back under curfew and Spain is once again in a national state of emergency, Lane’s guidance now seems wishful thinking. ECB President Christine Lagarde along with fellow Executive Board members Fabio Panetta and Yves Mersch as well as Bank of Spain Governor Pablo Hernandez de Cos have all acknowledged the growing threat to the economic recovery, which Lagarde said ‘risks losing momentum’ as a result.

That said, this is not March. The ECB already has at its disposal a pandemic emergency purchase programme (PEPP) featuring a flexibility that allows asset purchases to be adjusted ad hoc with respect to timing, asset classes and jurisdictions. Some could argue that the ECB is thus already positioned to a meaningful degree to counter pandemic-related eventualities.

That may help explain why Bank of France Governor François Villeroy de Galhau, when asked in a interview two weeks ago whether a worsening of the situation would induce the ECB to flood the markets with liquidity as in March, reacted unenthusiastically. Citing John Maynard Keynes – ‘When the facts change, I change my mind’ – Villeroy added: ‘But we are not there yet. Right now, our monetary policy, which in any event is accommodating, is appropriate.’

If the ECB on Thursday confirms that still, ‘we are not there yet’, Lagarde will be all the keener to strike a dovish tone when speaking to the press. That would be needed perhaps less to console financial markets that did not particularly anticipate a move this month anyway. But she may feel a particular need to satisfy those Council members who seemed ready to act even before the second wave of the pandemic grew to its current proportions, as well as any colleagues who have since joined their ranks.

Indeed, in such a case, Lagarde could do more than just hint that sights are set on December. After all, monetary authorities have been insisting all along that they are monitoring closely and stand ready to adjust their policy instruments. Some Council members may fear the stark choice is also about ECB credibility and not just talking the talk.

And if deferring action to December simply won’t do it and the non-negligeable possibility of a move this month materialises, then the ECB has never been shy when it comes to lauding the timeliness and forcefulness of its reaction to the initial wave of the pandemic. Justifying proactiveness under the current circumstances should not prove an insurmountable challenge.