Europe’s Surging Prices Beat Lockdown Risk for ECB Officials

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The European Central Bank’s markets chief and the Dutch National Bank governor urged an end to emergency stimulus, highlighting inflation risks while insisting the recovery can weather new pandemic restrictions.

Executive Board member Isabel Schnabel and Governing Council member Klaas Knot both suggested increasing vigilance to the threat of soaring prices, just weeks before a crucial decision on the future of asset purchases. 

“The risks to inflation are skewed to the upside,” Schnabel said in an interview. That was the most hawkish comment yet from one of institution’s top team of six officials before the December meeting, and together with PMI readings it prompted investors to resume bets on an interest-rate hike next year. The plan to terminate emergency bond buying in March is “still valid,” she added.

The euro-area economy is facing a double whammy of headwinds, as a fresh wave of Covid-19 infections threatens to slow activity while inflation pressures notch up to record levels amid ongoing supply disruptions. A purchasing managers’ index for the region on Tuesday showed business optimism at the lowest level since January. 

“The impact on inflation will actually be more ambiguous, because it might also reinforce some of the concerns we have around supply bottlenecks,” Knot, one of the ECB’s most hawkish officials, told Bloomberg TV. Despite new restrictions, “I don’t think myself that it will have an impact on our intention to wind down the pandemic emergency purchase program.”

Their comments came against a backdrop of intensifying focus on Germany, the region’s biggest economy. The Bundesbank warned on Monday that inflation data next week might show a surge close to 6% this month, while Chancellor Angela Merkel urged new tight restrictions to bring record infections under control.  

With such an uncertain economic backdrop, Schnabel and Knot both proposed that the ECB should seek to maintain room for maneuver in its upcoming decision on Dec. 16. The meeting has been flagged as pivotal in determining the future of stimulus after emergency bond-buying expires in March.

A key debate at the core of the ECB’s decision has centered on the possibility of a backup option in case of market fragmentation. 

The 1.85-trillion euro ($2.1 trillion) pandemic bond-buying program was launched in the early days of the crisis and did away with many of the restrictions that previously characterized the ECB’s quantitative easing. But officials haven’t yet clarified how much of that versatility will remain.

Among possible options are a transfer of the flexibility to the ECB’s regular quantitative-easing program and the creation of a new facility that would act as an insurance measure.

Bank of France Governor Francois Villeroy de Galhau has described such a mechanism as a “virtual toolbox” to give the ECB options contingent on circumstances. Ireland’s Gabriel Makhlouf urged the bank on Tuesday to maintain “optionality in our policy tools” so as not to become locked to commitments that put price stability at risk.

Schnabel said it’s “certainly” important to retain some flexibility, and indicated that the emergency program could continue to play a role in fulfilling the goal. 

“The PEPP will not disappear once net asset purchases have been reduced to zero,” she said. “Sometimes people talk about ending the PEPP. The PEPP is not going to end in March.”

Knot suggested that one way of maintaining versatility is through the ECB’s pledge to reinvest maturing debt. For example, officials could use redemptions toward bonds of different jurisdictions or maturities.

“We’ve already committed that we will reinvest at least until December 2023,” Knot said. “We will have to migrate that flexibility also to the reinvestment phase in order to prevent undue fragmentation.”

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