ECB Charts Lone Crisis Stimulus in Choppy Wake of Shifting Fed
European Central Bank officials are gearing up for a new phase of crisis response where their ultra-loose monetary stimulus becomes an increasingly lonely effort while the rest of the world moves on.
The institution’s approaching challenge is how to keep supporting Europe’s nascent economic rebound against a backdrop of shifting policy trajectories by counterparts such as the Federal Reserve, that could augur wild swings in financial markets and potentially push up borrowing costs throughout the region.
“The ECB doesn’t want markets to price in for Europe what they’re going to be pricing for the U.S., either in terms of policy normalization, the end of quantitative easing or let alone interest-rate rises,” said Marchel Alexandrovich, an economist at Jefferies International Ltd. “They’ll want to spell it out in detail to establish the understanding that European markets are a long way behind the U.S.”
With such dangers in mind, officials are already starting to emphasize the variance in recovery stages and inflation risks on either side of the Atlantic. President Christine Lagarde did just that in the European Parliament last week, stressing that the euro zone and U.S. economies are “clearly in a different situation.”
After a year when world monetary authorities collectively deployed massive stimulus, the ECB’s effort to keep up such a stance is indeed starting looking increasingly distinctive.
Weekly bond-buying under its 1.85 trillion-euro ($1.55 trillion) pandemic emergency program actually accelerated last week to the fastest pace since the height of the crisis.
Aside from the Fed, central banks in the U.K., Canada, Norway, Sweden, South Korea and New Zealand are all showing signs of at least thinking about a pullback. Mexico, Hungary and the Czech Republic raised interest rates just last week, following hikes earlier in 2021 in Brazil, Turkey and Russia.
The Fed itself brought forward expectations of rate increases at its decision this month. Officials may use their annual symposium in August at Jackson Hole to send another signal that they’re ready to reduce bond buying, as they monitor a more advanced rebound than the euro zone, with accompanying risks of faster inflation.
Money markets reacted the most to the Fed’s hawkish pivot, almost erasing ECB rate-cut bets and instead preparing for the first 10 basis-point increase in the deposit rate in 2023. Yields on German 10-year debt climbed to their highest since May in the aftermath.
That bond move was tempered by ECB Chief Economist Philip Lane, who told Bloomberg Television that policy makers may not yet have every piece of hard data they want when they meet in September, suggesting they may keep up their elevated pace of stimulus for longer.
The main threat for Lane and his colleagues is that higher interest rates will spill into the euro area before the economy is ready to cope with them. That’s the scenario officials faced in March, when they ramped up monthly purchases under the pandemic program to limit the effect on yields.
The ECB’s ultra-loose stance could still keep the euro weak, helping to lift subdued inflation by making imports more expensive, and enhancing export competitiveness. Robin Brooks, chief economist of the Institute of International Finance in Washington, has called the currency’s strength “one of the biggest imbalances in the global economy.”
Even so, climbing interest rates may have a more immediate economic impact than foreign-exchange movements, and could soon raise questions “about whether the ECB is doing enough,” said Alexandrovich. “Markets will focus inevitably on the stress in the system.”
According to George Cole, a rates strategist at Goldman Sachs Group Inc., such a focus could be intense. He expects any spillover from Fed rate-hike expectations to be higher than in recent years, and forecasts euro-area core yields to rise by up to 10 basis points as incoming data strengthens in the third quarter.
What would further complicate the ECB’s task would be an even faster shift in U.S. policy.
“There’s a risk if the Fed surprises in terms of timing or the size of tapering,” said Katharina Utermoehl, an economist at Allianz SE. “That could create more pronounced spillover effects.”
The ECB’s response to such challenges may rest on its communications, not least if a Fed plan for a policy exit throws focus on when the euro-zone institution might wind down its own pandemic bond-buying program, which ends in March 2022.
In such a situation, ECB officials would be well advised to signal their intentions rather than letting speculation build and making the market even more vulnerable to swings, according to S&P Global Ratings economist Sylvain Broyer.
“If the Fed really announces something at Jackson Hole, then it would be good for avoiding too much volatility on European markets not to wait too much,” he said, adding that Germany’s elections in September and the run-up to the French presidential vote next year could also stoke instability. “This is an environment that could become toxic for markets.”
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