ECB’s Weidmann: Don’t See Any Significant Deterioration of Financing Conditions

3 March 2021

By David Barwick – FRANKFURT (Econostream) – The increase in nominal yields does not at this point require new policy action from the European Central Bank or anything more than monitoring and anaysis, ECB Governing Council member Jens Weidmann said Wednesday.

Presenting the annual report of the German Bundesbank, which he heads, Weidmann said that ECB monetary policy was ‘not about yield curve control, which is implemented by the Bank of Japan, but rather, it’s ultimately about these financing conditions having a very important indicator function.’

Monetary authorities ‘naturally have to take a holistic approach’ that recognizes that ‘[i]t’s about the financing costs of the non-financial sector’ and considers ‘an entire range of variables’, he said.

‘And if we are quite precise, then it’s naturally the increase in real financing costs that interests us above all’, he added. ‘And it also isn’t the case that every increase in financing costs would be a monetary policy problem.’

Weidmann noted that an upwards adjustment of inflation expectations, ‘which currently is very much intended by monetary policy … would naturally not be a development that we would counter with monetary policy if this is correspondingly reflected in nominal interest rates.’

Similar examples drawn from real economic developments would include an improvement in underlying fundamentals or the economic outlook, both of which would also boost real interest rates, he said, but ‘would be a development that would be less problematic than others.’

The increase in nominal interest rates spilling over from the U.S. and the increase in government bond yields has less to do with the financing costs of non-financials, he said.

‘Briefly, we should keep an eye on these developments and analyse the background precisely’, he said. ‘We are fundamentally able at any time of course to flexibly adjust the volumes of the PEPP [pandemic emergency purchase programme] that are deployed, but in my view we don’t yet see here any significant deterioration of the financing conditions. The financing conditions continue to be in historical comparison very favourable.’

Weidmann noted the large gap between short-term inflation, which he said the ECB would look through, and ‘more relevant’ medium-term inflation, which he said would climb gradually, being held back by weak demand and capacity under-utilization.

It remains an open question, he indicated, how pent-up demand will affect prices, but monetary policy could always counter this if needed ‘and this seems to be reflected in expectations.’

As for higher nominal long-term yields, ‘Decisive for us at the end of the day is how these changes in the financing costs are transmitted to inflation developments’, he said, noting that the ECB’s primary goal was ensuring price stability.

‘Against this backdrop, the increase is not so significant that a really significant impact on inflation could occur’, he said.

The ECB disposes of ‘possibilities of reacting to the change in financing costs’ such as applying existing policies more flexibly. ‘It’s precisely for this that we have flexibility’, he said.

Were the increase to be deemed ‘problematic’, he said, ‘then of course we must act if this is the case. But according to what I know, this is not now ascertainable.”

It is important that policy not react ‘mechanically’, but rather monitor real developments and underlying causes, he said.

‘Naturally it was correct to act boldly in the crisis’, he said. ‘Nevertheless, I am of the view that we mustn’t lose sight of the risks of our actions.’

The economic outlook hinges on a medical resolution of the pandemic, Weidmann said. If the vaccines bring the pandemic under control, ‘the German economy will recover durably’.

‘Therefore, our experts do not fundamentally question their forecast of last December’, he continued. ‘However, the further course of the pandemic remains highly uncertain - and with it the economic outlook.’

In the much less favourable scenario the Bundesbank considered, the German economy would need until end-2023 to return to pre-pandemic output levels, and would sustain lasting structural damage, he said.

Weidmann reiterated his insistence that ‘monetary policy maintain sufficient distance from monetary government financing.’ The share of Eurosystem-held government bonds ‘should not become too large either’, he said, lest the discipline of financial markets be undermined.