ECB Brief: Schnabel Adjusts the Goal Posts; Crisis Phase Defined by Inflation

28 May 2021

By David Barwick – FRANKFURT (Econostream) – European Central Bank Executive Board member Isabel Schnabel on Friday effectively adjusted the goal posts defining the limits in time of the ECB’s extraordinary measures.

In an interview with Reuters, Schnabel was in essence asked whether the euro area remained in the crisis phase of the pandemic. The ‘crisis phase’ is what the ECB had declared to be the period during which its emergency support measures needed maintaining, but it was never clearly defined.

‘We are still in the middle of the pandemic’, Schnabel replied. ‘It is far from over, neither from a health nor from an economic perspective. … a relatively large part of the economy remains in a state of emergency.’

But this, she suggested, wasn’t even what really mattered. Rather, ‘the main thing to look at is the inflation projection’, she said. ‘This is the ultimate yardstick against which we measure whether the emergency is over, since we said that our tools are meant to offset the negative effect of the pandemic on the inflation outlook.’

With that, Schnabel made clear that brighter economic prospects also did not make much difference per se. That allowed her to admit to an improvement in the environment with a frankness not previously seen from the ECB Executive Board, which most recently seemed to have been in a state of denial in this regard, doubtless out of concern that an explicit recognition of better days would only encourage speculation about a withdrawal of support.

Progress in vaccinating citizens, fewer new Covid-19 cases and the removal of containment measures give the ECB ‘reasonable confidence that we have reached a turning point’, Schnabel now said. Higher demand backed by ‘quite strong’ sentiment indicators and ‘sharply’ higher consumer confidence ‘sets the stage for a firm recovery.’

‘The short-term outlook has brightened’, she said. ‘We can be confident that a large share of the population will be vaccinated by the end of the summer’.

If ECB President Christine Lagarde echoes Schnabel’s language on June 10 and thus relegates real developments to the status of a rather secondary consideration for monetary policy, this would give her the freedom to stop straining to avoid the mere mention of upside risks, all while emphasising that monetary policy is nonetheless in this for the long haul.

Schnabel was asked whether the pace of pandemic emergency purchase programme (PEPP) purchases could now be restored to the level of the first part of the year. The question represented a ‘fundamental misunderstanding about PEPP’, she suggested in response, and called to mind the ECB’s commitment last December to preserving favourable financing conditions for the duration of the PEPP by buying flexibly according to market conditions.

The ECB can certainly argue that when it said in March that it would be stepping up the pace of PEPP purchases ‘over the next quarter’ – a phrase Lagarde variously repeated at the time - it never explicitly said ‘only’ the next quarter. Still, if the misunderstanding Schnabel had in mind referred to this, then the ECB at least contributed to it.

Without saying now what the ECB would do, Schnabel made clear that monetary policymakers felt no precommitment, even implicitly, to slow the pace: ‘In June we’re going to look at the drivers of financing conditions, we are going to consider additional aspects such as seasonality, and we’ll analyse the inflation outlook’, she said. ‘This joint assessment will then determine what is going to happen with our asset purchases.’

In case anyone failed to get it, Schnabel doubled down: ‘The whole concept underlying the PEPP is inconsistent with the idea that there will be a mechanical tapering of asset purchases. We always have to be willing to reduce or increase asset purchases in line with our promise to keep euro area financing conditions favourable and to offset the impact of the pandemic on the inflation outlook.’

Perhaps so as not to provoke too much opposition, Schnabel strongly implied that regardless of the outcome on June 10, a renewed expansion of the PEPP might not be necessary. The remaining envelope being still ‘quite large’, she said, ‘[f]or now, it doesn’t impose any restrictions on our decisions.’

Indeed, she continued, a discussion of the envelope’s size is ‘premature’ and ‘will become relevant only well into the future.’ As this would depend on financing conditions and the end of the pandemic crisis, according to her, projected inflation would presumably be the key variable to watch, based on her previous comments.

And are financing conditions currently still favourable? Schnabel left this somewhat open, calling recent nominal yield developments ‘more clearly related to an improvement in the euro area’s growth outlook rather than to foreign spillovers’ and thus ‘precisely what we would expect and what we want to see.’

Real yields having been broadly stable, ‘from this perspective, I would certainly say that financing conditions remain favourable’, she said. However, the fact that government bond yields have been outpacing risk-free rates could be of concern, she said.