ECB Insight: Lagarde Delivers Optionality and Flexibility; ECB More Open-Minded

16 December 2021

By David Barwick – FRANKFURT (Econostream) – European Central Bank President Christine Lagarde on Thursday managed to deliver a set of decisions that preserved a high degree of optionality and flexibility and showed growing open-mindedness at the ECB about what would follow currently elevated uncertainty.

Following through on her prediction in October and the repeated, albeit not unreserved assurances of various Governing Council members thereafter, Lagarde announced the end as of next March to net purchases under the pandemic emergency purchase programme (PEPP), but took what Econostream on Tuesday preferred as the ‘clearer solution in which the PEPP’s end-March retirement is announced but it is made explicit that the programme can be reactivated if need be.’

‘Now given the uncertainty, we wanted to have as much flexibility and as much optionality as available’, Lagarde said to account for the decisions to lengthen the PEPP reinvestment period until at least the end of 2024 rather than, as previously, 2023, and to keep the programme what she called ‘open-ended’, adjusting ‘in either direction depending on the data that we receive.’

The potential to resume net purchases, along with the Council’s declared intention to reinvest maturing bonds flexibly, may have constituted an elegant solution to potential headaches.

For one, there was the matter of possibly endowing the asset purchase programme (APP) with the PEPP’s flexibility, to which some members of the Council were clearly attached, or creating an entirely new programme and then making it flexible. Either of those options, however, would have encountered internal resistance and possibly opened the ECB to charges of disproportionality.

The PEPP, however, is already flexible, so while it is a safe assumption that not everyone was happy – Lagarde spoke of a ‘very, very large majority to support the overall package’ – sticking with an existing tool must have offered the path of least resistance.

For another, extending the reinvestment period must also have facilitated the inclusion of Greek sovereign debt – after all, the idea that PEPP reinvestments would be as flexibly handled as net purchases could hardly be less sellable than any other solution including Greece. The reinvestment and the potential reactivation of net purchases could be reasonably counted on to stave off fragmentation, perhaps until Greek’s credit rating is lifted anyway.

Lagarde made sure to leave the ECB room to manoeuvre. ‘Now we’re not making any specific commitment, if you read carefully our statement’, she said of asset purchase volumes post-PEPP. ‘We land at €20 billion [per month] in October, and we keep it opened, and we will maintain it at €20 billion until such time when we arrive at our target…’

She indicated that the ECB was fairly open-minded about the need to adjust in one direction or other, and was again careful to rule out as ‘very unlikely’ a rate hike only next year, avoiding mention of 2023.

‘That still stands’, she said of higher borrowing costs in 2022. ‘But we have to be very attentive to what data tells us, and we will do so at each and every monetary policy meeting.’

As Econostream on Tuesday predicted, she played down Omicron by observing economies’ progressively better ability to shrug off such developments. ‘It will have impact, but in the first place we should acknowledge that our economies have become more resilient, stronger and are more capable of adjusting wave after wave after wave and variant after variant’, she said.

Moreover, she left open the variant’s possible inflation effect. ‘It might have a dampening impact on demand… but it might also have an impact on the supply side as well’, she said. The balance of inflation ramifications ‘is still totally uncertain.’

The ECB was visibly at pains to avoid falling back into the trap of systematic underestimation of inflation developments. The new set of forecasts – ‘a small 1.8 [for 2023] and a slightly higher 1.8 for ’24’, Lagarde said - generally exceeded expectations of observers accustomed to the ECB’s tendency to err on the downside.

‘… we are really making progress toward target’, she said, language unthinkable from her just months ago. The ECB was ‘not quite’ there, however, she continued. ‘Is there an upside risk? There is possibly an upside risk.’

Second-round wage effects were not yet clearly apparent, she said, but she did not minimise the likelihood of their emergence, instead reiteraring that the outcome ultimately depended on still-uncertain energy price developments and the adjustment between supply and demand.

Given the unusual profusion of conflicting commentary in the weeks leading up to this policy meeting, today’s outcome would seem to suggest that Lagarde managed to produce a very respectable degree of unity. One wonders whether she took the opportunity to urge that at least through the rapidly approaching holidays, the façade of a somewhat united front be maintained.