Exclusive: Econostream Understands Even October Could Still Be Seen as Premature at ECB
26 August 2021
By David Barwick – FRANKFURT (Econostream) – As Econostream continues to speak to people close to European Central Bank monetary policymaking, the expectation expressed here 10 days ago of a relatively uneventful September 9 Governing Council meeting has only been reinforced, with even the October 28 meeting seen as potentially too soon for big decisions.
As things now stand, net purchases under the pandemic emergency purchase programme (PEPP) are slated to end next March, which is what will happen unless the Council takes specific action to extend the programme. As authorities have repeatedly made clear, the PEPP is supposed to be limited in duration to the crisis phase of the pandemic.
Even those in the know sometimes struggled a bit with the question of how the end of the crisis phase will ultimately be determined, with one person Econostream spoke to calling it ‘something that is very hard to measure and that for me is very hard to anticipate as well’, although also ‘an essential discussion to eventually deciding whether to extend the PEPP or whether to stop it in March 2022.’
However, two others agreed that central bankers should not pretend to be epidemiologists and that the key issue would be the impact of public health measures taken in response to the pandemic on economic activity, financing conditions and monetary policy transmission.
By that standard, barring unforeseen developments, it seems as of this writing that the PEPP could end next March, but none of Econostream’s interlocutors thought any decision would be - or needed to be - forthcoming two weeks from today.
‘Why frontload something which would only be effective from March next year, when there is so much uncertainty still going on with the pandemic?’ said one. Indeed, he implied, even after September, there would still be ample time to come to a decision.
‘To me it’s obvious that, if the variants allow, there will be plenty of meetings where the governors can meet each other and discuss these things over and over again’, he said. ‘I don’t see any reason why the September meeting would somehow have to be the decisive meeting [or] why it should be more important than the following three meetings, for example.’
Another policymaker reinforced the view that the Governing Council could easily defer things for a while yet. ‘If you want to … make it public at the end of winter, most likely you start discussing it sometime in the autumn or early winter’, he said. ‘Before we would come out on this, most likely we will take some time to discuss it.’
One decision does however need making on September 9, namely the proper PEPP purchase pace for the fourth quarter. Financing conditions should drive the decision, but monetary authorities need to keep in mind the math that says deferring a slowdown in the pace – let alone increasing it – would, ceteris paribus, exacerbate potential cliff effects.
At an event on Wednesday, ECB Vice President Luis de Guindos said that a ‘gentle decline’ would be his preference and one he predicted ‘will be shared by many members of the Council.’ Of course, the ECB could engineer a ‘gentle decline’ of the PEPP purchase pace without starting in 4Q, or at least not at the outset of 4Q, by simply extending the programme’s life beyond March.
A PEPP extension is not out of the question. One person Econostream spoke to said in this context that there did not need to be ‘complete unanimity on the timing of whether it will be phased out in March, June or even September [of 2022] with very gradual declines’ in the pace of asset purchases. But a decision to extend the PEPP is unlikely to come now, if at all.
For the moment, the more likely course of action would be to initiate a slow descent in any case. Taking advantage of the opportunity of favourable financing conditions to reduce the pace ‘would be a sound argumentation at least to me’, said one person. ‘If the rates, if the yields, if the spreads, everything is under control, I’m not sure whether one needs to continue with the current asset purchase pace.’
The lack of any tightening in financing conditions recently – no one Econostream spoke to felt otherwise – is thus convenient, given that the current juncture could be considered a reasonable moment to start scaling back asset purchases anyway.
A slowdown would not even need to be all that slight, said one person who bluntly described the current situation as ‘six months before the end, with quite high purchases’ at present.
‘We purchased less in Q1 and we rescaled it back up in Q2’, he said. ‘I wouldn’t say that the reason for the tightening of financing conditions in Q1 was the lower pace of our purchases; it’s just that because things had eased, we were able to go with slower purchases, and then when it tightened again, we had to step back in. I wouldn’t prejudge what the September decision on this will be, but it’s based purely on the financing conditions.’
The same person suggested that a clear deceleration of asset purchases now would actually be a prudent approach. ‘You can say that being cautious would be if your baseline purchase figures wouldn’t consume the whole envelope, so that you can increase the purchases if things get worse, especially if you are making the decision at a rather stable moment in time’, he explained.
While people agreed that the Delta variant introduced an additional note of uncertainty, no one sounded as though it would exert great influence over monetary policy. One person who professed as a result of Delta to being just a little less certain than in June about whether the emergency would be over by March insisted that, regardless, vaccination programmes had been successful and would bring about an end to the emergency in the foreseeable future.
Another rejected Delta-driven worries in favour of looking strictly at the data. ‘If everything goes like the current baseline is, I don’t see why I should now think that we continue past March if I was not thinking already like that in June’, he said. ‘I haven’t seen that kind of deviation in the baseline.’
Moreover, he emphasised, a return to some form of normality regardless of the coronavirus was inevitable. ‘We need to understand that this could be something that, even with the vaccination, we need to live with for multiple years, and we need to somehow normalise our way of living, even with the variants’, he said. ‘I’m sure that the virus will still be with us when the PEPP programme is over.’
Those Econostream spoke to were quick to remind that even a discontinuation of the PEPP on no account meant an end to asset purchases, for one reason because proceeds from maturing bonds would continue to be reinvested for the time being.
‘Even if we discontinue with PEPP and say, “Okay, the pandemic phase is over”, we are far from seeing our inflation forecasts at the target, which means that we need to continue with some type of monetary accommodation’, one person observed. ‘The APP is not being discontinued when the PEPP will be discontinued. So asset purchases will continue, because our primary mandate is not satisfied even if the pandemic ends.’
The September 9 Governing Council meeting will also bring revisions to staff macroeconomic forecasts. The dominant view among those who spoke to Econostream was that the June projections were at the very least holding up. However, there was little optimism regarding medium-term inflation.
Although there had been some price increases, ‘if we don’t see them being passed on to wages, it’s hard to see sustained inflation’, one person said. ‘And the wage increases, they still have not been that great. … What is most important is what happens to wages in Germany. I’m not sure whether Germans in general have still accepted that inflation could be 2% on average and symmetrical.’
Still, some upside risks to inflation were seen stemming from US fiscal policy as well as from fiscal measures in Europe, particularly if the latter were counter-cyclical and productivity-enhancing.