The Fed Buys the ECB Some Taper Time
(Bloomberg Opinion) -- Policy-making for the post-pandemic period has begun.
Common sense made a welcome reappearance in the debate over the sudden jump in recovery-induced inflation when Federal Reserve Chair Jerome Powell acknowledged on Wednesday that there are upside risks to the U.S. central bank’s forecasts that aggressive price gains in some sectors will fade away. Though a lot of the recent surges may indeed prove transitory, monetary authorities have to recognize there are perils that may emerge if inflation expectations become entrenched.
The big winner here could be the European Central Bank. It now has a clear opportunity to highlight its own slower path compared to the Fed’s.
The U.S. is now formally talking about talking about when it might taper — with the late-August Jackson Hole central bank symposium the likely venue for announcing when it might start reducing its $120 billion per month QE bond-buying. When the Fed turns, the rest of the global central banks also shift. Whether slightly ahead or behind, the direction of travel is linked. The Bank of Canada has already started tapering. The Bank of England may decide to get a march on the Fed on Aug. 5, by further trimming its weekly purchases at a meeting when it assesses its quarterly economic forecasts.
Technically, the ECB could begin to discuss tapering as early as its Sept. 10 governing council meeting. On Thursday, however, its Chief Economist Philip Lane told Bloomberg TV that it is still “premature” to talk of reining in its QE bond-buying. Powell’s subtle but significant shift makes this more believable. The ECB can watch how markets respond to the U.S. central bank's approach — and if there is any repeat of the 2013 Taper Tantrum that made then-Fed chair Ben Bernanke quickly revert to continuing QE.
As Viraj Patel, macro strategist at Vanda Research, tweeted “rolling out Lane post a hawkish Fed yesterday is one of the smartest things they've done in recent months... clearly communicated that the ECB and Fed are on different paths. Draghi would’ve been proud.”
The ECB was always at the back of the pack for when it would tighten policy: The euro-area economy was on the verge of recession going into the pandemic and its fiscal stimulus response is only just properly starting. This impression of now-is-not-the-right-time was strengthened after the dovish June meeting and subsequent action this week to extend bank capital relief.
Lane also highlighted that a lot more economic data needs to be assessed as the NextGenerationEU 800 billion-euro recovery fund starts to be deployed across the bloc’s weaker economies. It makes sense to have real-time information on how sustainable the recovery is before lifting the throttle.
The ECB is especially focused on how favorable financing conditions are, hence extending to March 2022 the relief for banks on excluding deposits at central banks in calculating leverage ratios. The last thing the ECB wants is to accidentally choke off corporate access to loans during recovery. The other key factor is the strength of the euro. While the Fed’s actions have seen the common currency slip below 1.20 to the dollar, the governing council will be monitoring closely to see if conditions for exporters become less favorable over the summer.
There are of course risks to the ECB buying time, as the rise in the 10-year German Bund yield to a three-week high illustrates. When U.S. Treasury yields change sharply, so largely does the rest of the world. If the euro-area benchmark were to test the zero-yield boundary it would change the dynamics for all the other EU sovereigns (and their companies) that trade at a spread premium to it. Keeping bund yields pinned down is just as important as not letting Italian BTP yields soar: The two are umbilically linked. So a rapid yield rise, as was seen globally in February, would likely directly worsen euro-area financing conditions (though European bank shares might benefit).
Nonetheless, potential panics aside, the ECB has the Fed to thank for restoring some balance to market expectations on the central bank reaction to inflation concerns. This buys time. Nowhere needs it more than Europe, which has a lot of heavy lifting to do to boost growth that has long lagged the rest of the developed world.
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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