Global Daily – ECB policy shifts are on the cards

Since the ECB announced the outcome of its Strategy Review last week (see our note here), a quite a few Governing Council officials have spoken. A number of conclusions emerge. First, the change in the inflation framework following the review, with a higher inflation target and the need for a ‘forceful or persistent’ response when close to the lower bound, would be made operational at the upcoming meeting. Executive Board member Isabel Schnabel said the Council had to decide on the ‘concrete effects that the new strategy will have on our current monetary policy stance. It is clear that we must achieve our medium-term inflation target in a sustainable manner’. ECB President Lagarde noted that the July meeting would  be ‘important’ and will have ‘some interesting variations and changes’. She added that ‘given the persistence that we need to demonstrate to deliver on our commitment, forward guidance will certainly be revisited’.

Second, the ECB was already thinking about this also in the context of the post-PEPP era. Ms. Lagarde suggested that after the PEPP ends in March 2022, it could ‘transition into a new format’. However, the timing of any new guidance on the PEPP is unclear. While ECB Vice President Luis de Guindos said that the PEPP ‘transition’ will be decided in the ‘near future’, the President was more cautious saying that ‘we need to be very flexible and not start creating the anticipation that the exit is in the next few weeks, months’. The Governor of the French central bank, Francois Villeroy also supported this view, saying that ‘we have at least four such meetings between now and the end of the year.’

We think that the tools that the ECB will focus on in its aim to getting inflation to its new goal over the medium term are policy rates and the APP. These are the tools where the current forward guidance is contingent on inflation. We think that the ECB will strengthen its forward guidance to signal a longer period of unchanged policy rates and net purchases under the APP than markets currently expect. It will also signal that it is willing to increase the APP going forward and change the modalities to increase its room for maneuver. However, concrete steps in terms of the latter, will likely wait until the September or even the December meeting. This is because it will go hand-in-hand with the announcement of the wind down of the PEPP, which seem unlikely to be announced this month. Once the PEPP ends, the APP will likely need to be increased from the current EUR 20bn monthly pace.

Overall then, over the coming months, we are likely to see the PEPP being replaced by a prolonged period of accommodative policy, with current levels of policy rates and APP continuing likely through 2023. There is a risk that the PEPP is extended beyond March 2022 because of the risk that the  Delta variant disrupts or even reverses the opening up of economies. However, that is not our base case.