ECB Insight: Governing Council Likely to Want to Avoid Perception of Policy Inflection Point

8 June 2021

By David Barwick – FRANKFURT (Econostream) – In contrast to the high expectations for June prevailing in the aftermath of March’s anti-climactic Governing Council meeting, this week’s gathering of the European Central Bank is likely to be less of an inflection point following recent comments by ECB officials that seem to preordain the policy outcome and foreshadow the tone at the subsequent press conference.

The clarity provided at the end of last month by Executive Board member Isabel Schnabel regarding the limits in time of the ECB’s extraordinary measures was of particular importance. She effectively defined what has often been called the crisis phase of the pandemic – the period when almost everyone can presumably agree on the need for extraordinary measures – by explaining that ‘the main thing to look at is the inflation projection’.

The inflation projection ‘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’, she said.

The importance of this is hard to overstate, since the ever more apparent lifting of the economic clouds would have otherwise provided a backdrop, convenient for some, for a discussion of another kind of lifting, namely of the extraordinary measures.

It has long been obvious that a substantial subset of the Governing Council, and probably an even larger faction of the Executive Board, is far from ready for such a discussion. Schnabel in effect implied that brighter economic prospects did not per se make much difference.

Logically enough, having thus cleared the air, Schnabel was able to admit to an improvement in the environment with a frankness not previously seen from the Executive Board, whose state of denial in this regard has doubtless reflected the concern that an explicit recognition of better days would only encourage unwelcome speculation about a withdrawal of support.

That includes President Christine Lagarde, whose obstinate avoidance of any mention of upside risks on April 22 contrasted with the subsequently released account of that meeting showing upside risks to have very well gotten explicit mention. Under the probably safe assumption that Lagarde’s view of how to define ‘crisis phase’ is consistent with that of Schnabel, Lagarde should feel more comfortable this time around acknowledging the more positive landscape.

This could lead to a refreshingly honest press conference - at which Lagarde would nonetheless still go to lengths to quash the notion that brighter prospects meant the ECB would not continue to dependably provide a bridge to the other side of the pandemic.

As for a slowdown in the pace of PEPP purchases, a mere question about which Schnabel said was illustrative of a ‘fundamental misunderstanding about PEPP’, there is no ‘mechanical tapering’. As she was effectively rejecting the idea that the pace of PEPP purchases was subject to any automaticity, with everything hinging on the commitment to preserve favourable financing conditions for the duration of the PEPP by buying flexibly according to market conditions, it makes less sense for Lagarde to retain the wording of a ‘significantly higher pace’ – even if the current pace is kept up - and thus continue to imply that there exists any norm against which a given pace of purchases should be measured.

Of course, Lagarde herself on April 22 claimed that ‘there is no normal pace of purchase’. That would have been perfect had she not moments previously herself implicitly perpetuated the impression of a temporary departure from some default purchase pace by projecting PEPP asset buying ‘over the current quarter to continue to be conducted at a significantly higher pace than during the first months of the year.’

Lagarde may also draw from recent experience the lesson that, even if the joint assessment depends on updated staff forecasts and must thus take place on a quarterly basis, it may not be optimal to create the perception of a predetermined timeline by referring to ‘another quarter’ of whatever PEPP purchase pace emerges from the meeting.

Theoretically, much depends on the macroeconomic projections. But despite the good news lately, a game-changing upward revision is a less likely outcome of the exercise, and in fact the inflation prospects decisive for ECB support may scarcely budge.

That said, the March projections were out of date within days, as the $1.9 trillion US fiscal stimulus, signed into law on March 11, had not been taken into account by ECB staff. On April 14, Lagarde said that the ECB’s ‘preliminary assessment’ was that in the euro area, the US stimulus would add about 0.3 point to GDP and 0.15 point to inflation over the medium term, with 0.2 point of the growth impact occurring next year.

Speaking just two weeks ago, however, Lagarde referred to ‘quite a lot of factors and development that we are seeing at the moment that were actually already included in our previous projection from last March’, implying that recent positive data are largely baked in.

The fact that the ECB is not predisposed to slow the pace by no means rules out a deceleration, a scenario with a non-negligeable risk. Should there be one, it would be cautious in scope and accompanied by clear assurances that the ECB stands ready to move in the opposite direction if warranted. On no account would the ECB want a slowdown of purchases to be construed as genuine tapering or what could be thought of as the beginning of the end.

Asked two weeks ago whether, against the backdrop of accelerated vaccination campaigns and economic reopening, there was any chance the ECB would have to consider tapering in June, Lagarde rejected no less firmly than at the press conference on April 22 the notion that this was something the ECB was now ready to contemplate, calling it ‘far too early and … actually unnecessary to debate longer-term issues.’

‘Our focus in June is going to be on favourable financing conditions offered to the economy at large and to all sectors in the context of the inflation outlook’, she said, appearing to indicate that the focus would thus not be on tapering.

As for the PEPP envelope, there seems little reason to expect a change. 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.’

Whatever the outcome of the meeting, the ECB continues to see its role as being to ‘provide the right bridge across the pandemic well into the recovery’, in the words of Lagarde, who added, ‘And that’s what we will do. This will be the focus.’ A Governing Council meeting that comes across as an inflection point with respect to policy support is not what the ECB wants and is an outcome she will be at pains to avoid – even or indeed all the more so if there is an adjustment to PEPP.