Euro-Area Inflation May Justify End to ECB Crisis Mode, Says Knot
The euro zone’s inflation outlook may have improved markedly enough to justify an immediate slowdown in European Central Bank stimulus, an end to its pandemic emergency bond program in March, and then a return to pre-crisis discipline, according to policy maker Klaas Knot.
“I would expect a decision that should not be incompatible” with terminating the debt-buying plan in March, the Dutch governor said in an interview in Alpbach, Austria on Tuesday, discussing the options for next week’s Governing Council meeting. “That would imply a reduction in the purchase pace.”
The ECB has taken a more cautious approach than other global central banks such as the Federal Reserve, keeping policy ultra-loose to cushion Europe’s fragile rebound amid the prospect of a resurgent pandemic, even with inflation now at the highest in a decade.
Some officials including Knot are insisting that brightening prospects for the economy mean a line should be drawn on the current period of emergency policy settings. His colleague Robert Holzmann said in a separate interview on Tuesday that the improved outlook warrants a reduction in bond buying.
European government bonds fell on Holzmann’s remarks, and extended their decline after Knot spoke. The yield on 10-year German debt rose six basis points to -0.38%, the highest in more than a month.
An initial debate will take place next week on whether to keep up an elevated pace of debt buying. The Governing Council also needs to decide in coming months on whether to extend or end its pandemic debt-buying program -- known as PEPP -- in March, and how to continue its more conventional quantitative easing program thereafter, known as the APP.
“Both programs have been conceived under completely different conditions, and therefore the proportionality assessment that has been made at the start of these two programs has also been completely different,” Knot said. “Some of the flexibility that characterized PEPP would go against some of the safeguards that have been built into the APP.”
That suggests the Dutch governor will be among hawks at the ECB arguing that the APP should keep its stricter rules that currently insist that purchases should proportionately match the size of national economies -- a straitjacket that may limit the program’s scope because the institution has bought up so much government debt.
Knot, who spoke the same day as economic data showed an inflation surge in the euro zone to 3%, said that economic prospects may generally warrant a shift away from crisis settings.
“PEPP has a clearly delineated objective -- repairing the damage that the coronavirus has inflicted on the inflation outlook,” he said, adding that such a goal is within reach.
“The stars are much better aligned than they have been for a long time for the return of inflation back to 2%,” Knot said. He sees a “credible perspective” that 10% to 20% of the transitory spike in prices will feed through to higher wage claims in the region.
Knot cautioned that there does remain a risk of a resurgence in the pandemic, giving the ECB pause for thought before it winds down stimulus.
“I can understand that next week we may want to maintain some optionality, also to see how the delta variant will play out,” he said.
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