ECB Insight: ECB May Push Back Against Policy Sequencing Inversion Now, But Ultimately Embrace It

27 October 2021

By David Barwick – FRANKFURT (Econostream) – Of increasing interest lately is the possibility that the European Central Bank might ultimately deviate from monetary policy orthodoxy and start the lift-off from its low interest rates before asset purchases have come to a complete halt. An insider Econostream spoke to suggested such a sequencing inversion would ultimately prevail.

The issue stands a good chance of being raised at the press conference with ECB President Christine Lagarde tomorrow. For example, in a recent analyst research note, Citibank suggested that a forceful attempt by Lagarde to counter risen market expectations of, among other things, a reversal of the exit order would probably be ‘[t]he most important communication this week’.

Econostream believes that the ECB would risk creating the impression of being downright erratic if at the current juncture it were to call into question the standard sequencing or fail to push back against recent speculation, but is also aware that the idea has its adherents among central bankers.

The Bank of England is a notable example of a monetary authority sufficiently intrigued by the possibility of inverting the usual sequence to conduct a review of the order of policy tightening. In the euro area, however, a 2017 discussion paper by the Bundesbank favoured ‘a clear sequencing of the exit strategy, first stopping the asset purchases and later raising the policy rate.’

The person who spoke to Econostream on background expressed openness to the idea, going so far as to say that he did ‘not see a situation that first we need to stop asset purchases and only later on increase the interest rates.’

‘I can see possibilities of a combined strategy, that actually we can lift rates even before we completely phase out [net] asset purchases’, he said.

According to the ECB’s current forward guidance, net asset purchases under the asset purchase programme (APP) would ‘end shortly before [the Governing Council] starts raising the key ECB interest rates’, while the Council would ‘continue reinvesting, in full, the principal payments from maturing securities purchased under the APP for an extended period of time past the date when it starts raising the key ECB interest rates’.

There was ‘some chance’ of the ECB’s eventually decoupling the new forward guidance on inflation from that for asset purchases, but at present this is still just a ‘minority position’, the person Econostream spoke to said. For him, such a decoupling would be preferable he said.

The chances of this occurring depended in part on assessments of the harm negative interest rates were doing to the banking sector, he indicated. A potential way for the ECB to have its policy cake and eat it at the same time would be for the ECB to ‘think about going back to zero [with interest rares] but still purchasing some government bonds.’

‘It depends on the risk distribution in the system’, he added. ‘So, if the risk is concentrated very heavily in the financial sector, I can imagine such a decision.’