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December 16, 2021

The ECB Heads for the QE Exit—Where Is the Flexibility?

By Andreas Billmeier, PhD

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At today’s meeting, the European Central Bank’s (ECB) Governing Council (GC) decided on a gradual reduction of its monetary stimulus which, in the baseline scenario, is going to take most of 2022 to achieve. For 1Q22, it signalled a reduction in purchases under the Pandemic Emergency Purchase Programme (PEPP) compared to the current quarter and affirmed that the PEPP will end after March as expected. For the rest of 2022, the ECB plans to temporarily increase purchases under the standard Asset Purchase Program (APP) from its current €20 billion per month to €40 billion in Q2, €30 billion in Q3 and back to €20 billion from 4Q22 onwards, if and as long as necessary. The additional purchases therefore amount to around €90 billion, smoothing out the purchase trajectory considerably. In this context, it is worth noting that contrary to some expectations in the market, the ECB did not implement a new and distinct transition program for asset purchases in an attempt to reduce complexity at a time when asset purchase programs globally are falling out of favor. The GC also decided to extend the reinvestment horizon for the PEPP by one year to end-2024. In addition, it communicated much more strongly than it has before that, assuming a return to pandemic conditions, reinvestments can be handled very flexibly across time, asset classes and even jurisdictions—akin to what was the case for the original net purchases.

ECB staff also provided a new round of macroeconomic projections for the eurozone. The GDP growth trajectory was revised down 40 bps to 4.2% for next year and up 80 bps to 2.9% for 2023 as global supply bottlenecks are expected to last longer. In 2024, included for the first time, GDP growth is projected to slow to 1.6%. The much more important changes, however, came with the inflation outlook. 2022 headline inflation was revised up from 1.7% at the time of the September meeting to 3.2%. For 2023 and 2024, the projection stands at 1.8% for both headline and core inflation—a lot closer to the target of 2% compared to the September projection, especially for core inflation (30 bps higher).

Our View

Contrary to ECB President Christine Lagarde’s assertions of additional flexibility during the press conference, today’s meeting, in our view, looks like a major effort to reduce complexity and increase predictability in most outcomes—a win for the hawks. In providing the detailed QE guidance for 2022, the ECB today essentially said: “Don’t call us, we will come back to you in 12 months unless something changes.” That said, the new inflation projections surprised on the hawkish side, not only with respect to the high point estimate for 2022, but also by being very close to the target in 2023 and 2024. By revising the trajectory up this much, the ECB gains significant flexibility in the sense that it only requires a marginal tweak to its forecast in the middle of next year to fulfil the conditions for a rate hike sooner than expected. This could happen, for example, if wage growth were to pick up more strongly than expected. But as long as developments remain close to the baseline projection, the ECB has in fact become more predictable and maybe a touch less flexible by communicating so far in advance.

The other major takeaway concerns the PEPP reinvestment process. While Greece was not granted an exemption to become eligible for purchases under the APP, the language used today to describe the extension of the PEPP reinvestments essentially elevates the process to a new policy instrument that could support Greece if deemed necessary. By doing so, the ECB avoided the need for a new contingent program under which it would have been able to buy Greek debt.

Overall, today’s ECB meeting confirmed our expectation of higher government bond yields across the eurozone as well as steeper curves and wider spreads of periphery bonds as the ECB starts phasing out its purchase programs and slowly takes its finger off the scale.

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