Since the coronavirus pandemic hit Europe last year, conservative policymakers at the European Central Bank have put aside their discomfort over ultra-loose monetary policy to support the economy in the crisis region.
But even as the continent remains mired in rising infections, the “hawks” are urging the central bank to prepare to scale back its massive bond buying program.
This potential change, which risks dividing the ECB’s governing council and disrupting investors in eurozone bond markets, is expected to be discussed at the bank’s monetary policy meeting on Thursday, even if action is little. likely before its next meeting in June at the earliest.
When the eurozone was plunged into a record post-war recession last year, economists praised the ECB for massively stepping up its bond buying activity with its emergency purchase program in the event of pandemic (PEPP), which has helped keep borrowing costs low for governments, businesses and households. .
After twice expanding the size of the emergency bond purchase program last year, the ECB still has almost half of the remaining € 1.85 billion to spend under the PEPP. It plans to maintain net purchases at least until March 2022 and only stop once the pandemic crisis is over.
However, even as the eurozone economy remains weighed down by rising Covid-19 infections and containment measures, more belligerent members of the ECB board argue that it should start to curb its purchases of ‘obligations as soon as possible.
“Emergency monetary policy measures must not be allowed to go on indefinitely,” Jens Weidmann, director of the German central bank, told reporters in Frankfurt two weeks ago. “They must remain closely linked to the crisis and end once the pandemic is over.”
Klaas Knot, head of the Dutch central bank, went further a few days later, saying that if inflation and growth improved as expected from the second half of this year, then “from the third quarter, we can begin to phase out the pandemic emergency. purchases and end them as planned in March 2022 ”.
At the ECB’s most recent monetary policy meeting, board members all agreed to make PEPP purchases at a ‘significantly higher pace’ in the second quarter to avoid a bond market liquidation pushing up the costs of borrowing before a recovery takes hold.
But since then, its weekly net purchases have only increased marginally, leaving analysts scratching their heads and wondering if the recent rebound in sovereign bond markets has left ECB officials in doubt.
Frederik Ducrozet, strategist at Pictet Wealth Management, said the ECB board hawks “would only accept this anticipation of bond purchases on condition that they are further reduced in the third quarter and the PEPP is not or more broadened “.
With the ECB due to release new economic forecasts in June, which the Hawks expect to reflect an improving outlook for growth and inflation, they identified that month’s meeting as the first opportunity to push for a cut. bond purchases.
Most economists see the debate as premature, especially since eurozone output is unlikely to rebound to pre-pandemic levels until next year and is still lagging behind most. other major economies.
“These are hawk test balloons to see how the market reacts,” said Katharina Utermöhl, economist at Allianz. “But it is strange that the ECB is fueling discussions on this at a time when we are so far behind the United States, and even there the Federal Reserve continues to oppose any suggestion of reduction.”
Hawks have long been a minority on the ECB board and it is likely that there will be firm resistance to cutting bond purchases too soon. Christine Lagarde, President of the ECB, said last week that budgetary and monetary support would be “necessary in the recovery”.
Most analysts believe that Europe is unlikely to see a repeat of the ‘taper tantrum’ that sparked a liquidation in US Treasury markets in 2013 after the Fed announced plans to reduce the volume of purchases of bonds.
The main reason is that the ECB does not plan to end bond buying completely next year. Instead, it should step up its traditional asset buying program, which continues to buy € 20 billion in bonds per month and has recouped nearly € 3 billion since 2015.
François Villeroy de Galhau, Governor of the Banque de France and member of the board of the ECB, said this month that the end of the PEPP “would not imply a sharp tightening of our monetary policy” because the traditional purchasing program assets would continue and could be “somewhat adapted”.
Ducrozet de Pictet said the ECB will also continue to reinvest money from maturing bonds into its EUR 1.85 billion PEPP portfolio for several years, providing additional stimulus. “The market can handle an exit from the PEPP,” he said, stressing that government debt issuance is expected to fall from recent highs next year, which means the ECB will have less to buy.
However, the concern for the ECB is that inflation will continue to rise sharply, forcing it to tighten its policy even as the economic recovery in the euro area weakens and borrowing costs rise for the most indebted governments. .
Maria Demertzis, deputy director of the Brussels-based think tank Bruegel, said: “If inflation came back on a lasting basis, it would put the ECB in a very difficult position because we would still be in a very weak recovery and it would put a much heavier burden on it. on fiscal policy with an increased risk of financial market fragmentation. “
After falling below zero in the last few months of last year, euro area inflation has risen to 1.3% in recent months and the ECB expects it to exceed its target by one. just under 2% in the last quarter of this year, albeit temporarily.
The ECB said inflation was being pushed up by one-off factors which are expected to subside next year. But German inflation is expected to exceed 3% this year, and Weidmann recently warned that “we may have to face stronger inflationary forces again in the future.”
In a foretaste of the potential battle ahead, the Bundesbank chief said: “There can be no lack of determination, even as rising interest rates increase countries’ borrowing costs. . This is important for the credibility of monetary policy. “