ECB dials back pandemic support but signals no end to stimulus

Photo: EPA ECB President Christine Lagarde speaks during a press conference following the meeting of the Governing Council, 09 September 2021.

The European Central Bank will dial back its emergency bond purchases a notch over the coming quarter, it said on Thursday, taking a token step towards unwinding the emergency aid that propped up the bloc’s economy during the pandemic, Reuters reports.

The ECB pulled out all the stops last year as COVID-19 ravaged the economy but with growth and inflation now rebounding, policymakers have been under pressure to formally acknowledge that the worst is over.

The move was modest, however, and the ECB gave no signal of its next policy move, including how it might dismantle the 1.85 trillion euro Pandemic Emergency Purchase Programme (PEPP) which has kept borrowing costs low for governments and businesses.

“The Governing Council judges that favourable financing conditions can be maintained with a moderately lower pace of net asset purchases under the Pandemic Emergency Purchase Programme than in the previous two quarters,” the ECB said in a statement.

In the past two quarters, the bank has purchased around 80 billion euros worth of debt each month. It provided no numerical guidance for the three months ahead, but analysts had predicted prior to the meeting that purchases would fall to between 60 billion and 70 billion euros in those months.

Highlighting policymakers’ caution, the bank also maintained a long-standing pledge to ramp stimulus back up if markets turn and financing conditions require it.

“The Governing Council stands ready to adjust all of its instruments, as appropriate, to ensure that inflation stabilises at its 2% target over the medium term,” the ECB said.

The cut in bond-buying comes as growth exceeds expectations and the 19-country bloc proves unexpectedly resilient to the Delta variant of the coronavirus, thanks to its high rate of vaccinations.

End of crisis

All of that suggests that the crisis phase of the pandemic, the key condition of the emergency stimulus, is ending, making any extension of the scheme beyond its nominal end-date in March hard to justify.

But policymakers also fear that cutting support prematurely would undo years of stimulus - a dangerous prospect for the ECB, already struggling with a credibility deficit after nearly a decade of undershooting its inflation target.

Inflation, though now at a 10-year high, is expected to fall sharply early next year and again languish below the ECB’s 2% target through 2023, an outlook likely to be confirmed by new, somewhat improved, economic projections by the ECB on Thursday.

The ECB is also likely to have been keen not to make a big move before the U.S. Federal Reserve, which now appears somewhat hesitant to set its own course out of super-easy policy.

With Thursday’s decision, the ECB’s key rate remains unchanged at minus 0.5%, PEPP remains on track to end next March and purchases under the older Asset Purchase Programme (APP) remain at 20 billion euros a month.

Beginning of tapering

Thursday’s policy decision skirted the big issue around the eventual end of emergency support, a contentious decision that will probably be left for December’s meeting.

The difficulty is that the bank must signal the end of PEPP, its biggest asset-purchase scheme, as the coronavirus crisis ends, while promising to maintain support via other tools because inflation is still too low.

That will require the ECB to shift its focus to the more rigid, longer-established APP, the bank’s primary stimulus tool before the pandemic.

But to make the APP fit for purpose, the ECB will need to increase purchase volumes and make its rules more flexible - which conservative members of the Governing Council are likely to resist, fearing that the ECB is already acting beyond its mandate.

Especially important are rules that forbid the ECB from buying up more than one-third of any country’s debt or making purchases out of proportion to the size of a country’s economy.

Policymakers are also expected to clash on their assessment of inflation, with some increasingly arguing that the recent rise may not be as temporary as the ECB has predicted.

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