As pandemic emergency fades, expect ECB to dust off old tools
(Reuters) - As the coronavirus pandemic is slowly brought under control, the European Central Bank will have to phase out its emergency support measures. But with recent data showing euro zone inflation still far from its target and growth sluggish, other tools are likely to take its place.
The 1.85 trillion euro Pandemic Emergency Purchase Programme (PEPP) has kept the 19-country currency bloc afloat through a double-dip recession but it was always intended to be a temporary measure and a revival in economic activity will open a discussion about when and how it should be ended.
PEPP formally expires in March 2022 and policymakers are unlikely to signal at their next meeting in June that they will start winding the scheme down, especially since government bond yields are already inching up to uncomfortable levels.
That will make "emergency" measures harder to justify and leave further purchases under PEPP open to challenge, both within the ECB's Governing Council and in court, a potential threat to the central bank's credibility.
HOW WILL IT MANAGE THE TRANSITION?
The first step towards ending the scheme could be a shift in emphasis away from emergency buying of government bonds to the totality of the ECB's purchases under PEPP and its older Asset Purchase Programme (APP). The APP, which operates under more rigid rules, was introduced in 2014 to avert potential deflation in the bloc following the global financial crisis.
But there is nothing to prevent the ECB from ramping up APP while reducing PEPP, especially since the bank is still failing in its primary mandate of keeping inflation close to 2%, which was the justification for launching the older programme.
Consumer price growth is still only seen at 1.4% in 2023, far from the ECB's target and -- more importantly -- way below levels projected before the pandemic. That suggests the COVID-19 shock will linger for years, essentially requiring the ECB to keep up copious support.
WHAT DO POLICYMAKERS THINK?
Policy doves from the euro zone's more vulnerable southern economies, including ECB Vice President Luis de Guindos and board member Fabio Panetta, have meanwhile argued that keeping stimulus in place for too long will be less costly than removing it too quickly.
Big government deficits are another reason the ECB will have to keep pumping in stimulus.
Next year's budget deficit forecast of 3% of GDP for the euro zone as a whole hardly looks realistic given that massive subsidies are keeping large chunks of the services sector from collapsing during the pandemic.
In either case, the ECB is on the hook and policymakers will oblige.
HOW WILL MARKETS REACT?
Fears of a negative market reaction also add to the case for signalling copious support beyond PEPP.
There is little logic to removing support quicker when the economy is coming back from its biggest peacetime shock in a century.
The cost of shifting to the APP is that it doesn't allow the ECB to focus its purchases on countries that need it most, as it will have to follow pre-determined quotas at least roughly.
PEPP, in contrast, gives the central bank discretion over what, when and how much it buys.
