The European Central Bank is all but certain to dial back its stimulus one more notch. This is while pledging to keep supporting the financial system, by sticking to its long-held view that alarmingly high inflation will abate on its own. There is pressure mounting on the bank to follow its global peers in turning off the money taps. Stepping back too quickly could unravel years of work to rekindle once anaemic inflation.
The ECB’s dilemma is further complicated by an unusually uncertain outlook. This could force rate-setters to delay many of their big decisions. This is until the new year. The compromise is likely to be clarity on the framework of ECB policy in 2022. Inflation, now running at more than twice the bank‘s 2% target level, comes down quickly in 2022. Bond buys under a 1.85 trillion-euro Pandemic Emergency Purchase Programme will be reduced next quarter. A long-running Asset Purchase Programme, will be ramped up. Some of the lost stimulus, will be compensating.
The overall purchases could be left at around 40 billion euros a month. The effective cut in stimulus could be much smaller. Fresh government debt issuance is expected to fall. Hence, the ECB will continue to hoover up most of the new debt. The ECB is also likely to signal that it will keep buying bonds throughout the year. The problem is that while the ECB will project inflation falling back under target in 2023 and holding there in 2024. Luigi Speranza, chief global economist at BNP Paribas stated that it makes sense not to provide the parameters of the new asset purchase programme. They could provide the general principles but delay an announcement on the calibration and exact volumes.
The U.S. Federal Reserve’s signal that it would end pandemic-era bond purchases in March. They raise rates three times next year. The most likely option is that ECB policymakers approve a bond purchase quota and emphasize that not all of this must be spent.
The bank will then regularly review the exact volumes. Purchase targets are set only for short period. It is also likely to increase its spending on supranational debt. This is to support Next Generation EU spending. The biggest risk is that investors start dumping bonds from the bloc’s indebted periphery. This increases the premium governments, that there need to pay to borrow. To mitigate this risk of fragmentation, the ECB could say that the roughly 100 billion euros left in the emergency programme. This could still be used in case of market turbulence and cash from maturing bonds may be used flexibly. So that, the ECB could spend more in stressed markets.
The ECB will also have to address the issue of Greece. The ECB is likely to signal that reinvestments may be skewed towards Greece while it remains ineligible for new buys. Berenberg said in a note to clients that rarely, they have the backdrop for a major ECB decision been as uncomfortable and as uncertain as it is now.