ECB’s Lane: Have Flexibility to Counter Increase in Yields if Necessary

26 February 2021

By David Barwick – FRANKFURT (Econostream) – The European Central Bank will exploit the flexibility of its policy tools if the increase in yields being observed necessitates action, Executive Board member Philip Lane said on Friday.

In an interview with Spanish daily Expansión posted to the ECB’s website, Lane, who is also chief economist, conceded that ‘[i]t can be problematic if market optimism moves ahead of the current state of the economy.’

The ECB is ‘carefully monitoring the rise in yields’, he said, noting in the next breath that the staff forecasts for inflation would be updated shortly. In any event, he continued, ‘it’s important to remember’ that the ECB’s pandemic emergency purchase programme (PEPP) ‘will be used flexibly in response to market conditions.’

If circumstances warrant, the ECB’s market operations ‘can also be conducted in a flexible way between meetings’, he added.

Asked whether the ECB’s bond buys could respond to yields that rise with expected inflation, Lane said that the volume of previous purchases had had ‘a very large downward effect’ on European interest rates, while additional buys undertaken in response to ‘significant market movements’ can stabilise markets.

‘But at the same time, it is crystal clear that we are not engaged in yield curve control, in the sense that we want to keep a particular yield constant’, he said. ‘With the purchase programme we are trying to move the curve in a certain direction and with enough force to support inflation dynamics.’

As to the open question of a sudden increase in inflation, Lane said the ECB was ‘looking very carefully at measures of inflation compensation’. The ‘mix of a rise in expected inflation and an increase in the inflation risk premium’ that it sees ‘is actually good news, because it shows that scenarios of the world economy heading into deflation are much less likely.’

Noting the latest staff projections calling for 1.4% inflation in 2023, which he called ‘still very low’, Lane assured that ‘lots of support is still needed for it to climb upwards.’

‘What we’re seeing now is not a significant and persistent change in the path of inflation’, he said. ‘At this stage, an excessive tightening in yields would be inconsistent with fighting the pandemic shock to the inflation path.’

Europe faces ‘no risk of overheating’, he said, given that policy support ‘has been very active, but at levels that are nowhere near the scale of the US stimulus.’

The ECB ‘[w]ithout a doubt’ continues to dispose of firepower, Lane said, citing its liquidity-creating ability and the still-present possibility of lower interest rates. ‘We remain confident that if we decided it was the correct decision to make, we could move interest rates’, he said.

The ECB ‘wouldn’t say we could use this tool if we didn’t believe it’, he said. ‘[W]e do all sorts of calculations and analytics to make sure that it’s a credible and honest statement.’ It remains the case that the PEPP and the TLTROs are best suited to the current environment, ‘but the pandemic is of course not the only shock that could hit the economy and we have to be prepared’, he said. ‘All the tools are available.’

‘There is no hard limit’ to monetary policy despite central bankers’ consistent reminders about the importance of fiscal policy, he said. ‘The issue is more about the efficiency or the scale. The recovery will be faster and the efficiency will be better if fiscal policy makes its contribution.’

Although banks might ‘prefer less demanding targets’ to meet the funding conditions of the ECB’s targeted longer-term refinancing operations (TLTROs), he said, ‘we have to strike that balance’. Funding conditions are ‘very favourable’ even for those banks falling short of TLTRO lending requirements, he said.

Potentially lower take-up by banks of liquidity this year ‘is not a proper comparison’, as ‘the current situation is different’, he said. ‘What we should be looking at is whether our decision to extend the programme is benefiting the European economy, and we absolutely think it is.’

Whereas his Executive Board colleague Isabel Schnabel yesterday had said merely that 1Q growth ‘may be somewhat weaker than expected’, Lane implicitly wrote the current quarter off, saying that ‘[i]n the second quarter activity will already start to recover compared with current levels.’

Further out, Lane was similarly optimistic, noting ‘the prospect of vaccinations bringing a sea change in the second half of 2021.’ Like Schnabel, who had spoken of ‘substantial uncertainty due to the new variants of the virus’, he said that the timing of the economic ‘rebound’ would depend on the coronavirus mutations.

Though Lane responded in slightly more guarded language than Schnabel when asked whether the staff forecasts might be revised down, in the final analysis he appeared not to take another view than the latter, who had affirmed that 2021 growth was ‘likely to be in the same ballpark as projected in December’.

Lane thus called it ‘a bit early to answer that because we haven’t finished preparing them yet’, but like Schnabel, seemed more focused on the positive, viewing the negative as strictly near-term. He, too, observed that the economy had grown accustomed to coping with lockdown measures and that China had returned to fast growth.

‘So if the lockdown lasts a few weeks longer it won’t have much of an impact on the final growth picture in 2021’, he said. ‘We think a lot of the pandemic shock will have been offset by the end of the year.’

He did not, however, repeat his assertion of less than four weeks ago that ‘‘[w]e expect economic growth and inflation in the euro area to return to their pre-pandemic levels before the end of this year.’ While Schnabel yesterday had said that euro area output ‘should be back at its pre-crisis level by mid-2022’, Lane today avoided any such prediction.