Europe and the ECB Keep to the Glide Path of Doves

Europe and the ECB Keep to the Glide Path of Doves

The European Central Bank, at a major review of its pandemic stimulus, very carefully chose not to adopt any of the hawkishness that both the Federal Reserve and the Bank of England displayed this week. This was as dovish a QE taper as the European government bond market could ever have hoped for. Under the time frame these measures encompass, the ECB won't be contemplating interest rate hikes until 2024 — at the earliest.

President Christine Lagarde was at pains to explain how accommodative the Governing Council had been as it laid out the plans to end the pandemic QE program (known as PEPP) in March as planned. The key was to make sure that its preexisting replacement, the Asset Purchase Program, is — for all intents and purposes — a carbon copy.

The surprise elements of Thursday's major ECB review were an exit clause: PEPP can restart if the economy falters. And the timing is flexible because there is no end date for the APP.  The central bank has thus provided itself with a reverse gear to rapidly restart bigger stimulus if the economy stalls. It has learnt its lesson from being under-prepared and inflexible going into previous crises. And so quantitative easing — what was once an unconventional monetary policy tool — has become fully conventional and a permanent part of central banking. At least in the euro zone.

Re-investments for maturing holdings in PEPP were also extended by a further six months, at least to 2024. It is a powerful tool that equates to around 150 billion euros ($169.5 billion) extra of annual purchases. By this time next year, QE buying will still equate to at least 30 billion euros per month once re-investments are included. As usual, the actual planned pace for this next quarter was left vague but Citi analysts reckon it will about 50 billion euros monthly of outright purchases, slowing again to 40 billion euros in the second quarter when the APP takes over. It’s a taper, for sure, but one on a very gradual glide path.

Several euro countries, including Germany and Italy, were on the verge of recession before the pandemic hit, which explains the extraordinary monetary and fiscal response to the emergency. That’s also why its understandable that stimulus medicine remains firmly in place in the euro zone for the foreseeable future. The ECB’s forward projections on economic growth show a return to a more standard pre-Covid pace of 1.6% for 2024. Lagarde said it’s unfair to compare the euro area to either the U.S. or U.K., both of which started from a very different base.

Perhaps more importantly, and optimistically, the ECB’s inflation projections show it believes the current price spikes will pass and consumer prices will return below the 2% target by 2023. A 3.2% euro area inflation forecast for 2022 is substantially below what the Fed and BOE have earmarked — and with November CPI running at 4.9% annually, it’s a somewhat brave prediction. It is still technically the biggest jump ever, from the previous forecast of 1.7% in September.

A large majority of the 26 member Governing Council supported the announced measures. But the hawks are still there biding their time.

It wasn't all sunshine and roses. Some of the flexibility of the pandemic response has been lost in the change of acronyms. Greek bonds rose in yield as they will not be part of the APP, one of the many rigidities the PEPP was designed to correct. However, Lagarde explained that the PEPP reinvestment machine will still be operating in the background and this will allow the ECB to buy sufficient Hellenic debt. Trust us, she said in essence. Other peripheral countries’ debt such as Italy and Portugal sold off too. But that is perhaps just market nerves that the security blanket is now smaller. It’s not necessarily less effective. Lagarde’s smooth reassurances saw yield rises subside.

All in all, it was a successful first step to weaning the euro area off record QE. But be in no doubt the ECB has yet again erred on the dovish side and seems determined to plow its own furrow. It’ll leave the swifter stimulus reduction to others. There is plenty of work still to be done to reinvigorate the euro economy.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

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