ECB Insight: Council Members’ Comments Suggest a Cautious Start to QT Start Doable in 1Q
21 November 2022
By David Barwick – FRANKFURT (Econostream) – As the public discussion of the European Central Bank’s approach to quantitative tightening heats up, one can venture some guesses about what will materialise, based on Governing Council members’ contributions to that discussion.
(For those wishing to see the comments alone, an updated collection can be found here.)
One of the most common elements across hawk-dove lines is the desire to proceed carefully. In calling it ‘appropriate that the balance sheet is normalised in a measured and predictable way’, ECB President Christine Lagarde on Friday was merely the most prominent voice to join the chorus.
Vice President Luis de Guindos (QT ‘must be implemented with a lot of prudence’), Banco de España Governor Pablo Hernández de Cos (‘we have to do it in a cautious and very gradual manner’), De Nederlandsche Bank Governor Klaas Knot (‘I see a case for caution’) and National Bank of Belgium Governor Pierre Wunsch (‘I would be for [being] cautious there’) are among others advocating circumspection.
In principle, the balance sheet is obviously seen as entirely fair game, given the widespread sentiment that authorities ‘should use all the instruments we have at our disposal’, as Bundesbank President Joachim Nagel put it.
Still, interest rates will enjoy primacy over other monetary policy tools for the foreseeable future or, in the words of Executive Board member Fabio Panetta, remain ‘a suitable marginal instrument of normalisation’.
Broad agreement also exists concerning the initial approach – ‘a passive QT by not fully reinvesting the maturing securities’, as de Guindos has said. The hawks seem quite okay with that. ‘Later on, we should and will talk about actively selling our asset holdings’, Latvijas Banka Governor Mārtiņš Kazāks, for example, said recently. ‘But it’s still way too early for that.’
Moreover, it is clear that QT will focus on the asset purchase programme (APP), with pandemic emergency purchase programme (PEPP) holdings continuing to serve as a safeguard against market turbulence.
Lagarde herself has stated unequivocally that ‘flexible reinvestments under the pandemic emergency purchase programme and the new transmission protection instrument − will remain in place’, so that the PEPP forward guidance, which sees principal payments reinvested until at least the end of 2024, for now remains valid.
That is the straightforward part. Beyond the plan to specify key principles in December, policymakers are guarded when it comes to timing issues. At least two – Nagel and Kazāks – are explicitly thinking of early next year, which we assume means the first quarter, though the latter hedged his bets somewhat by saying this was ‘unless the economic outlook changes sharply’.
We think Knot is also in the Q1 camp, making the case as he did last week ‘for an early but partial stop to reinvestments, to test the waters before calibrating the ultimate pace of the roll-off’. And we group Wunsch here as well, with his desire to ‘start early and cautiously’.
Banque de France Governor François Villeroy de Galhau may be in less of a hurry than his more hawkish colleagues. Whilst he has said that ‘we could start earlier than 2024’, he favours a ‘clear sequencing’ in which banks repay TLTRO funds before QT starts.
Other Council members who have given any indication as to their thinking with respect to timing have tended to emphasise a sequencing that could push the start of QT out yet further. In general, sequencing seems to be a can of worms.
For example, Bank of Greece Governor Yannis Stournaras wants the ECB ‘to only start reducing its bond holdings after the central bank is done with hiking rates.’
We suspect this is the least of his preferences, but even that may not fly; de Guindos, relatively familiar with thinking at the Eurotower, has said that ‘[t]he characteristics and the timing of our QT … may overlap or not with the process of normalising the interest rates’.
A particularly notable partisan of the go-slow approach is Panetta, who has insisted that authorities ‘should take the necessary time to assess the impact of our rate hikes and of phasing out the TLTROs’ and ‘should ensure that TLTRO repayments have been absorbed before we stop fully reinvesting the principal payments from maturing securities’.
He is not alone, with de Cos also having spoken of ‘first allowing markets to absorb significant TLTRO III repayments’ before full APP reinvestments end, and of the ‘need first to draw lessons’ from the effect on the balance sheet of last month’s TLTRO decision.
But here again, we see at least some resistance. Kazāks has said that he ‘would refrain from that specific sequencing of instruments’ and in general is not warm to the idea of communicating any precise sequence of steps.
Wunsch, though also generally sceptical of forward guidance, might meet de Cos and Panetta halfway, given his proposal to assess shortly into the QT exercise whether ‘there’s enough absorption capacity in the market’ before picking up the pace.
Even so, Panetta could be hard to satisfy. Not only does he want to ‘continually monitor the market response to our measures and consider the feedback between our different instruments’, but he has also suggested ‘a controlled reduction – whereby only redemptions above a cap are not rolled over’.
Considering how successfully the Governing Council overcame the hesitancy of the doves to hike interest rates, we doubt any of the various objections or the general reluctance of some member will slow things down much. Indeed, the apparently universal preference to be careful should help make for common ground on which to proceed.
Still, one thing we think we can rule out is that QT starts this year. That is based not only on all the above, but also on communication from Lagarde, who has said that informing observers about the key QT principles, due 24 days from today, ‘has to be of course in advance of the decision to implement and to roll out this reduction’ of the balance sheet.
When it does start – and 1Q is probably doable – then QT may be devoid of some of the surprises that have been part of the rate hiking cycle. This we say in view of the apparently shared desire for predictability.
This has been articulated explicitly not only, as noted above, by Lagarde (‘a measured and predictable way’), but also by de Cos (‘very gradual and predictable’), Knot (‘predictable, like watching paint dry’) and Villeroy (‘orderly, announced cautiously and well in advance’).