ECB: Limited Commitment and Guidance

Published on December 15, 2021
SGH Insight
The ECB will not change the sequencing of rate hikes to follow the end of asset purchases, and the Governing Council has repeatedly pushed back on the likelihood of 2022 rate hikes. That is probably even more so the case given the likely dampening effect of the surging Omicron variant on travel, hospitality, and economic activity at least in the very near term. But importantly, sources have also stressed that this push back does not extend to 2023, and there are no “guarantees” of no hikes beyond 2022. Frankly speaking, even the late 2022 pushback, while seen as extremely unlikely, is not 100% ironclad.

This means the ECB will not commit to asset purchases beyond 2022, and will, as we stated in our November 22 report, very likely seek flexibility to start the year higher, but gradually unwind the Asset Purchase Program through the course of the year. Flexibility of course can go both ways, resulting in higher as well as lower purchases, but the maneuverability that is sought is to end QE by the end of 2022 if all pans out as expected.
Market Validation
Policy Validation

Bloomberg 12/16/21

The European Central Bank expanded regular bond purchases for half a year to smooth the phasing out of its emergency debt-buying program and revamped the latter tool to combat future market turmoil, shifting its stimulus away from crisis settings.

Officials in Frankfurt confirmed their 1.85 trillion-euro ($2.1 trillion) pandemic measure, known as PEPP, will wind down as planned in March. To cushion that halt in emergency purchases, they temporarily boosted their conventional bond-buying tool.

The so-called Asset Purchase Program will double to 40 billion euros a month, starting in the second quarter. Policy makers will then taper to 30 billion euros in the following three-month period, before returning to the existing pace of 20 billion euros in October.

Italian bonds led declines in the region, lifting the 10-year yield eight basis points to 1% and widening the premium over bunds by four basis points to 131. German yields also climbed led by the long-end where 30-year rates rose above 0% for the first time since November. Money markets kept bets on a first 10-basis-point rate hike by end of next year.

The decision is an acknowledgment that emergency policy settings must come to an end in the face of the euro area’s fastest inflation since the single currency was created and as economic output nears pre-crisis levels.

Some last-minute comments to add to our European Central Bank meeting preview, “SGH 11/22/21, ECB: Rate Hike Optionality,” ahead of tomorrow’s Governing Council decisions, starting with a reminder of a key point from that report:

[The] ECB will seek to build some optionality into the revised Asset Purchase Program at its upcoming Governing Council meeting on December 16…That may entail a decision at that meeting to build in quarterly reviews of the pace of APP purchases once it is topped up from the current 20 billion euro per month pace to compensate for the expiration of the Pandemic Emergency Purchase Program in April of 2022. A quarterly review was built into the emergency PEPP program as well, and it is seen to have served its function there well.

The ECB will not change the sequencing of rate hikes to follow the end of asset purchases, and the Governing Council has repeatedly pushed back on the likelihood of 2022 rate hikes. That is probably even more so the case given the likely dampening effect of the surging Omicron variant on travel, hospitality, and economic activity at least in the very near term. But importantly, sources have also stressed that this push back does not extend to 2023, and there are no “guarantees” of no hikes beyond 2022. Frankly speaking, even the late 2022 pushback, while seen as extremely unlikely, is not 100% ironclad.

This means the ECB will not commit to asset purchases beyond 2022, and will, as we stated in our November 22 report, very likely seek flexibility to start the year higher, but gradually unwind the Asset Purchase Program through the course of the year. Flexibility of course can go both ways, resulting in higher as well as lower purchases, but the maneuverability that is sought is to end QE by the end of 2022 if all pans out as expected.

On that front, much has been made of a leak yesterday that the ECB projections will show inflation still below its 2% target for 2023 and 2024, even as the 2022 numbers are revised higher. We would caution in reading too much into that from a policy perspective, with markets already rightly expecting a very cautious, gradualist ECB and continued, highly accommodative policies.

For one, without impugning the rigor of the projections in any way, we would note that the forecasts would need to show medium-term inflation below 2%, otherwise the ECB would be facing questions over why it does not remove accommodation even more rapidly, and renewed pressure on rate hike expectations. It can always be revised and will likely be revised upward again. 

Second, while it is an easy call that inflation at these (eye-popping) levels indeed must surely be transitory, the extent and pace of reversion towards the 2% (or below) level is predicated largely on energy prices coming down, and base effects of German VAT increase and year on year comparisons. They do not say much about the broadening of inflation, even if gradual and clearly less than the headline figures would indicate.

Third, and related to that point, this forecast, which does not yet formally incorporate what has been estimated as a 0.2-0.3% of additional inflation from Owner Occupied Housing (OOH), is only marginally below 2%, and it was by and large expected, including to hawks. We would remind you again, from SGH 11/22/21:

As stated by ECB Governing Council Member and Belgian National Bank Governor Pierre Wunsch, while the 2023 staff forecast is likely to remain below 2%, “it wouldn’t take much for realized inflation in 2023 to be at 2% — one or two surprises or some second-round effects, so just a fraction of everything we’ve seen in the last three months.”

These differences in forecasts will clearly not be resolved over the next days or even weeks, but the ECB will need to build optionality and policy flexibility for the upside as it gauges the momentum behind underlying inflation impulses going into 2022, including when it rolls out the new “modalities” on December 16 for the 2022 Asset Purchase Program.

To stress that final note as the ship of ECB policy slowly turns, we would share a comment from an ECB official going into the blackout period that markets will need to understand there will be less security [and predictability] now than what they have been used to.

Adding to that, he notes that it is not just markets, but the public, and government authorities, that will need to gradually prepare for the possibility [we believe high likelihood] that barring some severe unforeseen developments, 2022 will mark the last year of the current round of asset purchase programs, even as the ECB keeps the APP and a potential PEPP-like contingency emergency program in case of wild gyrations in its back pocket.

 

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