The ECB Should Take a Page From the Fed's Playbook
(Bloomberg Opinion) -- Although European Central Bank President Christine Lagarde did not present at this year’s virtual Jackson Hole symposium, the Federal Reserve’s annual central bank policy forum, she was surely paying close attention.
One message in particular from Fed Chair Jerome Powell’s address could be very useful for her to replicate — that of using forward guidance to separate any early attempt to taper quantitative easing from an eventual hike in official interest rates. Keeping the unconventional bond purchases method distinct from the conventional tool of central bank policy would give the ECB what it desperately needs: time.
This is, of course, only a rhetorical device. Reducing any form of monetary stimulus leads to interest rate speculation — the two are inextricably linked in the eyes of the money markets. But it is a cunning move to buy more time to assess how sustainable the pandemic recovery is and whether current higher inflation proves to be transitory. Whisper it, but central bankers have no more clue about this stuff than the rest of us.
The move is already catching on in Europe. On Monday Bank of France Governor Francois Villeroy de Galhau, remarked that Powell “marked a disconnect in time on decisions on purchases and later on the rates … I think this disconnection probably applies on both sides of the Atlantic.”
It is quite likely this line will be echoed during Lagarde’s press conference following the upcoming governing council meeting on Sept. 9. There are big differences between the more advanced state of the U.S. recovery and the slower pace within the EU, but there might be similarities in policy approach.
The disconnection strategy comes conveniently ahead of what could be a difficult meeting for Lagarde. There is restlessness among the hawks on the governing council, who are pushing for the 1.85 trillion-euro ($ 2.2 trillion) pandemic QE bond-buying program to be scaled back before the nominal expiry date in March next year. There’s about 500 billion euros left in the envelope. The current monthly spend of 80 billion euro would be sufficient to use it all up, but several members likely won’t approve of maintaining it.
Villeroy hinted that the pace could be reduced for the fourth quarter, with remarks that financing conditions are more favorable than they were in June, adding to recent comments by ECB Chief Economist Philip Lane and Vice President Luis de Guindos that a discussion will be held. UBS Group AG economists expect a reduction to a 50-60 billion-euro per month range, roughly in line with the pace from the first quarter.
Euro-area growth and inflation forecasts almost certainly will be revised higher at this quarterly review, but that shouldn’t necessarily correlate to tighter policy. There is still a long way for the European economy to recover. Jefferies Financial Group Inc.’s weekly real-time tracker of the euro economy is only running at 82% of pre-Covid levels, substantially below both U.S. and U.K. levels that have largely returned to normal.
August consumer inflation in the euro area rose to a decade-long high at 3%, but more attention will be on core CPI nearly doubling to a 1.6% annual pace as prices of industrial goods soared. Yet after looking through expected higher food and energy prices, the basis effects of last year’s German sales tax cuts, and the results of earlier summer sales, there’s little reason for the ECB governing council to worry that inflation will prove significantly more than transitory. It is changes in inflation expectations that really spook central bankers, particularly in wages.
Nonetheless, with German headline inflation expected to rise to around 5% by November, there are clearly going to be some anxious voices at the next governing council. The loudest will perhaps come from Bundesbank President Jens Weidmann, who has asserted that the pandemic program, known as PEPP, must end when the Covid crisis is over. In early August he stipulated, “The first P stands for pandemic and not for permanent. It’s a question of credibility,”
Lagarde needs to balance calls for pulling back support with the need among weaker economies for more time for the 800 billion-euro NextGeneration EU recovery fund to gain traction. Monetary stimulus remains the vital grease that oils the fiscal wheels. Nominally separating the two key components of QE and interest rate policy, as the Fed is trying to guide, could well be one way to square the circle.
There is plenty of time to decide what replaces PEPP — and this will surely be needed — but a modest reduction in monthly QE buying could prevent a mutiny until the worst of the inflationary impulses subside. It is, after all, the most flexible tool the ECB possesses. It is important to display that monetary stimulus is not always a one-way direction of travel. How novel that would be.
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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