Thu. Jan 20th, 2022


European Central Bank policymakers are reconsidering the extent of their commitment to extra stimulus, reflecting growing doubt about how fast inflation is expected to fall as the Omicron coronavirus variant raises concerns about further price increases.

A trio of recent events have cast doubt on the minds of some ECB policy makers, who have been predicting for months that inflation will fall below its target and justify the continuation of major stimulus policies.

The first was the rise in eurozone inflation to 4.9 per cent in November, well above the ECB’s 2 per cent target and a record since the euro was created two decades ago. This was followed by the emergence of a new coronavirus variant, which threaten to prolong the pandemic and with it the bottlenecks in the supply chain that have pushed up prices.

Then late last week, the US Federal Reserve said it will accelerate the termination of its bond-buying bond program, which will put pressure on the ECB to curb its own asset-buying plans.

Ahead of the ECB meeting next week, analysts are worried that together they are increasing the chances of a “hawkish” shift by policy makers to withdraw stimulus earlier than investors expected, which increases the chances of a sale in the eurozone government bond markets. .

“At Omicron, it is clear that it will keep inflation for longer because the disruption of supply chains will take longer,” said an ECB board member.

“The pandemic has changed the structure of the economy, with more homework, a higher carbon price and a shift away from globalization,” the councilor continued. “In the medium term, inflation may be higher than our target and then we will have to act.”

Line chart of harmonized index of consumer prices (annual% change) showing Eurozone inflation sets new record

The central bank is expected to announce at its meeting next Thursday that it will suspend new bond purchases in March under the € 1.85tn emergency program launched in response to the pandemic. But ECB policymakers could also postpone a further decision on how many bonds they will buy in 2022 until early next year.

“I will be very uncomfortable committing to anything after the end of the second quarter of next year,” a second board member said. “Markets are just going to have to live with that.”

A third councilor said a delay in his decision on future bond purchases was possible “depending on the pandemic and new data in the next two weeks”.

The ECB has bought more than € 2.1tn worth of bonds over the past two years, recording more than the total net issuance of eurozone governments in an effort to keep borrowing costs low.

But analysts at UniCredit have calculated that this could change next year, even if eurozone governments are expected to collect less debt unless the central bank doubles the amount of bonds it buys under an earlier asset buying program to € 40 billion per year. month from April to the end of 2022.

Line chart of Eurozone deposit facility rate (%) showing the ECB lowering interest rates below zero

By continuing large-scale bond purchases next year, the ECB will be a significant outlier compared to other central banks that have planned to halt asset purchases soon, including the Fed and Bank of England. The Bank of Canada has already done so.

Consensus is growing across the ECB Council that there is little added benefit to increasing the monthly flow of asset purchases in terms of boosting inflation, according to two of its members. “It makes no sense to extend the asset purchase program to March,” one said.

Analysts think the ECB could commit to an extra “envelope” of bond purchases after March next year. But they said his decision is hampered by the fact that it is almost certain to raise its 2022 inflation forecast next week to well above 2 per cent, making it harder to justify a commitment to continue to trade large amounts of bonds buy.

“Upward surprises were big on inflation and the revision of the ECB’s 2022 forecasts will be one of the highest ever in the history of these forecasts,” said Frederik Ducrozet, strategist at Pictet Wealth Management. He expects the central bank to increase its inflation forecast from 1.7 percent to 2.7 percent next year.

Reinhard Cluse, an economist at UBS, said: “The forthcoming meeting is possibly one of the most difficult meetings for the governing body in recent times, given the contrasting pressure on its inflation mandate. Government bonds in the peripheral countries of southern Europe “appear vulnerable to a shift in ECB communications”, he added.

Christine Lagarde, President of the ECB, said last week that the bank was “very unlikely” to increase its deposit rate of minus 0.5 percent next year, as it still expected inflation to fall below its target by 2023.

Despite Lagarde’s remarks, price markets are still up 0.1 percent ECB at the end of next year, although investors bet on two rate hikes in 2022 a month earlier.

“They worked so hard on that message that it finally came through,” says Antoine Bouvet, rating strategist at ING. “Part of the reason it was so difficult is because of the Fed, whose influence is penetrating eurozone exchange rates.”

The ECB has pledged not to raise rates until it stops buying assets, which economists say is unlikely before 2023, even if it continues to reinvest the proceeds of bonds that expire long after. “They could complete asset purchases by mid-2023 and then it’s feasible to see a first rate hike at the end of 2023,” says Katharina Utermöhl, an economist at Allianz.



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