The meeting of Council of the ECB next Thursday precedes another decisive meeting, that of December, where economic forecasts and the tone of monetary policy will be decided. And this time, the last one is the background worsening prospects in the growth-inflation relationship. “The ECB finds itself increasingly between a rock and a hard place as the eurozone economy goes through a period of weakening, while inflation is at a record high and price pressure is mounting,” he cuts short. Martin Wolburg, senior economist at Generali Investments. In other words, the central bank's "goldilocks" scenario of the last decade, with (sometimes worryingly) below-target inflation, justifying exceptional policy measures and thus buoying activity and markets, is come to an end. Wolburg continues: «President Lagarde's main task in the political meeting in October will be to calm worries of the market that the ECB is waiting too long. The president will have to walk a fine line to keep inflation expectations under control without being forced by the markets into real political action. The implicit message will be that the threshold for raising rates is still far away. The markets are currently pricing in a 3-year zero, -0,15 2-year and -0,43 1-year deposit rate. He concludes: "Between the lines he will communicate that the (probable) upward adjustment of the inflation trajectory at the December meeting will not alter the prospects for rates and that the markets have gone too far in their expectations on their rise".
ECB COUNCIL: REDUCED PURCHASES BUT NOT IMMEDIATELY
Experts therefore do not expect major changes to monetary policy, nor the anticipation of the decisions of the December meeting. At its December meeting, the Governing Council will publish new macroeconomic projections, including the inaugural assessment for 2024, as well as communicate the plan for quantitative easing following the end of the current Pandemic Emergency Purchase Program (PEPP) in March 2022. The ECB currently purchases around €70 billion per month under the PEPP, plus €20 billion per month under the ordinary asset purchase program (App). “We think that the Governing Council will choose to gradually reduce the pace from the current €90 billion per month to a stable rate of between €40-60 billion per month during the second quarter of next year,” he says. Konstantin Veit, senior portfolio manager European rates at Pimco. He continues: «We also think that the ECB will maintain the current framework for reviewing the pace of asset purchases on a quarterly basis. Finally, we expect you to announce further targeted refinancing operations longer term (TLTRO) in December, albeit on less generous terms than during the pandemic crisis phase.
In short, what matters for the monetary policy stance is the total amount of asset purchases, while the division between programs is largely a political decision. Veit adds: «We expect the Pepp to end in March 2022, and that the ordinary App will in return be increased from the current 20 billion euros per month, given that progress towards the medium-term inflation target of 2% is still incomplete. The ECB could certainly decide to introduce a series of temporary purchases to facilitate the transition".
That is: once the impacts of the pandemic on the level of inflation are sufficiently neutralised, through temporary policy measures (such as the PEPP) and preferential liquidity arrangements (TLTRO), more regular instruments of asset purchases will come back to the fore refine the post-pandemic political framework starting from 2022. And he concludes: «the ECB's policy is aimed at reassuring the markets. The ECB will remain patient and will not repeat the hawkish mistakes of 2008 and 2011. The objective, however, is to reduce asset purchases to return to interest rates as the primary instrument of monetary policy».
ECB COUNCIL: OCTOBER AS A TEST
"At the next meeting, the ECB could not only reiterate its forward guidance, but also offer more information on the prospects for buying bonds in Europe, ahead of the key meeting in December". explains Gergely Majoros, member of Carmignac's investment committee. What, then, to say to bond investors? “Bond investors are faced with a short-term dilemma. Further caution on interest rate markets is certainly warranted, as the inflation cycle may still be undervalued, especially in the US, which would lead to a more aggressive monetary policy stance. At the same time, at the next meeting the ECB could decide to take a more accommodating position, indicating that it is in line with the current rate hike path, but postponing the start of the hike until at least the beginning of 2023. This is probably would push i again European bond yields lower down, at least temporarily.'
