The latest meeting of the European Central Bank’s Governing Council confirmed its very accommodative monetary policy, leaving its short-term stance unchanged: bond purchases will continue at a ‘significantly higher pace’ for the next three months relative to what was delivered in the first quarter of the year.
Financial conditions shall remain loose
The Council argues that financial conditions have “remained broadly stable,” but still worries about the possibility of a ‘premature’ tightening in conditions that “would pose a risk to the ongoing economic recovery and the outlook for inflation” – hence the decision to maintain the pace of asset purchases under the ECB’s quantitative easing (QE) programme.
While there was unanimity within the Council on the final statement, President Lagarde acknowledged there were differences on certain points. The hawks on the Council are unlikely to be quite so accommodating at the September and December monetary policy meetings.
A brighter outlook
The ECB had good news to report: “The latest data signal a bounce-back in services activity and ongoing dynamism in manufacturing production” and “indicators of consumer confidence are strengthening, suggesting a strong rebound in private consumption”.
The ECB also published its latest forecasts (see exhibit 1): The trajectory of GDP growth has been revised up significantly, largely reflecting a more positive assessment of growth in the third quarter.
The Council has revised its view of the risks around the growth outlook to ‘broadly balanced’. Last time around, the risks were tilted to the downside, but ‘more balanced’. These changes in code words are intended to be significant.
Lowflation to persist
The forecast for headline inflation in 2023 is unchanged on last time, so it is interesting that the Council chose to emphasise the fact that the forecast for core inflation has been revised up to 1.3% in 2022 (from 1.1% before) and to 1.4% in 2023 (from 1.3% before).
The fact that core inflation in 2023 has been revised up by only 10bp given a more than 1% revision to the path of GDP speaks to the limited sensitivity of inflation to slack in the ECB’s forecast methodology.
Core inflation is still falling far short of the ECB’s target.
Too early to talk about a taper
The Council resisted calls from some quarters to start reining in its monetary stimulus as the eurozone economy recovers and seemingly chose not to debate monetary strategy at this meeting.
President Lagarde stuck to her line that it was ‘too early’ to talk about tapering asset purchases under the pandemic purchase programme (PEPP) and what that would imply for purchases under the pre-pandemic QE programme (APP).
It is likely that the Council already expects to wind down the PEPP next year and knows that it will have to scale up the APP somewhat to compensate, but that it just prefers not to say so to avoid a bond market tantrum.
Clarity on the plan is likely to coincide with clarity on the conclusions of the central bank’s strategy review.
Talking the talk
Will the ECB ‘follow the Fed’ and adopt average inflation targeting in the review? It is not that easy to predict, but the most likely scenario is that it will adopt a commitment to achieve a symmetric inflation target in a (nebulous) medium term.
That would be sugarcoated with guidance that the ECB would keep its monetary stance loose and could tolerate an inflation overshoot as the economy exits from the pandemic.
Warm words about tolerating overshoots in the far future should be judged in the context of inflation having struggled to just reach the 2% target since 2013.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.