ECB Insight: Time to Make Clearer That Downside Risks Are Not the Only Ones

20 April 2021

By David Barwick – FRANKFURT (Econostream) – In recent weeks one might be excused for thinking that some members of the European Central Bank’s Governing Council live in dread fear of an economic improvement in the Eurozone that could lead to any withdrawal of monetary accommodation. Given that it has become significantly harder to overlook the likelihood of such an improvement, as the need to make important policy decisions approaches inexorably, ECB President Christine Lagarde’s role as mediator could take on new meaning this Thursday.

Though the Council is unlikely to make any major policy moves, and would lack updated staff macroeconomic forecasts to back these up, that does not imply a purely stock-taking exercise – even if Lagarde subsequently depicts it as such. As the question of when and how to exit from the ECB’s exceptional measures looms ever larger, it also grows more essential that the Council find some stable common ground on which to proceed.

At the moment, it is clear that such a foundation for decision-making is lacking. Despite the opaque language of the account of March’s monetary policy meeting, a widening rift was apparent. But then, scepticism was always warranted with regard to Lagarde’s characterisation of the March 11 decision as having been ‘by total consensus’, given the increasing and striking disparity of public comments.

On the one hand, there are those with Dutch National Bank head Klaas Knot, who recently said that ‘[i]f the economy develops according to our baseline, we will see better inflation and growth from the second half onwards. In that case, it would be equally clear to me that from the third quarter onwards we can begin to gradually phase out pandemic emergency purchases and end them as foreseen in March 2022.’ He was backed publicly by Austrian National Bank chief Robert Holzmann, and it can be assumed that Bundesbank President Jens Weidmann and a handful of other, less vocal Council members feel similarly.

Arrayed against them is the faction mentioned earlier: those stubbornly unreconciled to the idea that the euro area might emerge from the crisis and the patient be transferred out of intensive care. For example, Banco de España Governor Pablo Hernández de Cos last Thursday conceded that there was ‘light at the end of the tunnel’, only to then fret that ‘the tunnel may well lengthen, with the light at its end becoming dimmer.’

De Cos was speaking the day after ECB Vice President Luis de Guindos said that ‘[a]t the moment, risks from the early withdrawal of policies are higher than the risks associated with keeping support measures in place.’ That was the theft of a page from the playbook heavily relied on by his Executive Board colleague Fabio Panetta as well as by Banca d’Italia Governor Ignazio Visco, who recently seemed reluctant to embrace the IMF's 2021 Italian GDP projection and reiterated yet again the watchword that ‘perhaps a little bit postponing the exit is less worrisome than winding down too early.’

Bank of Greece Governor Yannis Stournaras tackled Knot’s suggestion head-on. The third quarter would be ‘too soon’ to start phasing out PEPP purchases, he said. ‘We don’t have any evidence that things will turn so benign in the third quarter. … The pandemic programme runs in principle up to March, but if needed, it can be extended.’

Back in March, when the issue was one of rising yields, the Council managed to paper over differences, albeit briefly. According to the cautiously worded account of that meeting, ‘all members joined a broad consensus … on the understanding that the total PEPP envelope was not being called into question in the current conditions and that the pace of purchases could be reduced in the future.’

The spirit from which such an agreement emerged appears to have been short-lived. Time is not on the Council’s side to revive it; the average pace of vaccination in Europe is picking up, the massive US stimulus will unfold an impact to be reflected in June’s ECB staff projections, China has reported solid first quarter economic growth, and evidence is mounting that economies are increasingly able to cope with containment measures. And no later than June, a decision must be made about the pace of PEPP purchases going forward.

Lagarde is somewhere in the middle of all this, her most recent comments suggesting in the aggregate that she is a bit torn. Two weeks ago, she told the International Monetary and Financial Committee that ‘[i]mproving global demand, also spurred by sizeable US fiscal stimulus, and the progress in vaccination campaigns constitute upside risks.’

That was a rare explicit acknowledgment of upside risks by Lagarde or indeed any Executive Board member. Neither at the March 11 press conference, nor in her appearance before European Parliament on March 18, did Lagarde mention upside risks as such, even if she called global demand, fiscal accommodation and immunisation efforts 'encouraging'.

The mention of these factors as clear upside risks in the context of a formal statement reflects the evolving view of things at the top of the Eurotower more meaningfully than Lagarde's remark in an interview on March 31, when she affirmed that medium-term risks were ‘much more balanced’, or in an interview last week, when she said the US fiscal stimulus was ‘clearly an upside risk’.

At one point during the latter occasion, she almost seemed to indicate support for Knot’s view, predicting that ‘in the second half of the year there will be recovery that will be moving fast’ and saying but a minute later of PEPP spending that ‘[i]f we can spend less because the situation improves fast, we will do so as well’.

But that is not the full picture. On every occasion, Lagarde has been at manifestly greater pains to convey the message that the ECB was far from even thinking of removing policy support. ‘We are still clearly dealing with a pandemic crisis’ and ‘swamped with uncertainty’, she said. ‘For the moment that support is needed, and that will be needed until well into the recovery.’

The press conference on Thursday will probably be another occasion for Lagarde to do her best to sit on two chairs at the same time while favouring one. In a bow to the reality of a brighter outlook, upside risks seem likely to get explicit mention, possibly in the introductory statement. This might also be an opportune moment to add a touch more optimism to the sentence on risks surrounding the euro area growth outlook.

But some aspects of the statement may not undergo much change. The accent will continue to be on downside risks, as it is easier to promise continued policy support – which she will undoubtedly vow - against a backdrop depicted as gloomy rather than sunny. Allaying fears of those concerned about the possibility of an early withdrawal of policy support will be high on her list of priorities.

Moreover, Lagarde will certainly want to point out that despite the anticipated 0.15-point medium-term impact of the US fiscal stimulus on inflation here, the outlook for euro area HICP remains below the ECB’s aim, with this year’s surge due wholly to transitory factors. She will emphasise the critical importance of widespread vaccination and reiterate the ECB’s unswerving devotion to favourable financing conditions.

The risk that Lagarde would have something to say about the PEPP’s fate is probably non-negligeable. However, she only recently reaffirmed that the PEPP would run until the crisis phase is over: ‘We’ve assumed that it would be March [2022] – up until now. If it needs to be extended because the Governing Council determines that the crisis is likely to last longer, we will extend it.’

Nevertheless, Lagarde could frame the larger question concerning the life of the programme in the context of the strategic review. Of particular interest would be the possibility of an outcome of the review in which aspects of the PEPP are ‘institutionalised’, making it easier for it to be allowed to expire on schedule.

Besides expressing satisfaction with the implementation of the March 11 decision, she could indicate under what conditions the present pace of PEPP purchases would be maintained, or not, beyond 2Q. At the same time, it would be early for her to pre-commit, especially as she last month suggested that such an assessment would take place in conjunction with the macroeconomic forecast exercises.

In an ideal world, Thursday’s meeting would be an opportunity for Council members to define enough common ground to facilitate future decisions. Given high uncertainty and the obvious trepidation with which some members regard the prospect of leaving the swaddling of the ECB’s exceptional measures, a durable understanding may be less likely, and in any case would not necessarily be communicated until the publication of the meeting account, if then.

Still, even if that can is kicked a bit farther down the road, there would be something won if Lagarde, in her role of mediator, merely convinced her colleagues to dial back the current cacophony of conflicting positions.