What the ECB thinks about next year

What the ECB thinks about next year

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The future of European Central Bank stimulus is getting clearer before December's crunch meeting, with its pandemic bond-buying tool on track to be wound down as planned, but remains available for reactivation if needed.

That is a consensus after weeks of public debate among officials who gather in Frankfurt in three weeks due to soaring prices and the sudden re-imposition of lock-downs in parts of the continent that are casting a shadow on the recovery in the 19-member euro area.

The goal for policy makers is to plan a path for post-crisis stimulus to ensure there is sufficient support through the latest wave of infections, without risking too much inflation. The ability to respond quickly to shocks and avoid commitments over too long a time horizon is what officials are hoping to achieve in 2022 with an interest-rate increase.

The loudest voices of late have struck a hawkish tone despite the rising threat from the virus. Isabel Schnabel, a member of the ECB's six-strong Executive Board, told Bloomberg this week that inflation risks are skewed to the upside. Here is what we learned about the thinking before the Governing Council makes its decisions on December 16.

The emergency purchase program known as PEPP will come to a halt in March, according to officials. The release of an account of their last meeting underscored that intention.

Launched in the early days of the coronavirus crisis, the tool did away with many limitations that guided earlier bond buying, giving the European Central Bank more flexibility to deal with market stress.

Policy makers must determine whether to ramp up regular asset purchases to smooth the transition, and how long it takes to get some room to address fragmentation on sovereign-bond markets.

Four officials - Schnabel, Francois Villeroy de Galhau, Klaas Knot and Robert Holzmann -- spoke out this week in favor of keeping that flexibility on hold within PEPP. It could mean a pledge to reinvest redeemed debt if necessary, or a more strategic use for restarting purchases.

Knot said Tuesday that the flexibility within PEPP has served us quite well. We will have to migrate that flexibility to the reinvestment phase in order to prevent unnecessary fragmentation. While Germany s Bundesbank warned price growth in the region could approach 6% this month, officials are cautioning about upside risks to the longer-term outlook. They will be given new forecasts, including a first look at how prices may develop in 2024, at the December meeting.

The Governing Council's decision will be affected by whether the current spike will continue to be seen as largely transitory.

They may choose to make stimulus plans with a shorter timeframe in mind. Ireland spokesman Gabriel Makhlouf argued this week for maintaining optionality in policy tools so as not to be locked into commitments that put price stability at risk.

Some of the more subdued tone on inflation is still being heard at the same time. Executive Board member Fabio Panetta made a case that the short-term price spike could act as a tax on demand and pull the economy away from absorbing excess slack, requiring more monetary-policy easing.

The idea that conditions for an interest-rate increase could be met next year has been pushed back by ECB officials across the board. One topic for discussion is how long a gap between the eventual end of bond-buying and the first hike, though Schnabel downplayed the need for that debate to happen in December. She said that a continuation of long-term loans could be determined later on. Villeroy agreed that some decisions could be taken beyond December.

But Schnabel, who is in the running to become Germany's next central bank chief, did argue that other tools and how the ECB communicates its reaction function will probably gain a more important role than bond-buying.

She said there are diminishing returns to asset purchases and increasing side effects on the other hand. There will be a shift from asset purchases towards other tools, most importantly, our forward guidance. None of the Wildfires Are Worse, and One Chemical Company is Reaping the Benefits.

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