BofA experts believe the market could get nervous if the ECB does not show its policy roadmap very clearly
The European Central Bank (ECB) is holding a new monetary policy meeting this week from which practically nothing is expected. The eyes of the market will be on the statements of Christine Lagarde, president of the ECB, looking for the slightest clue about the future of stimuli in the euro zone. This conclave, which is expected to be quiet, could be the last before a new dispute begins within the central bank. The economic recovery and inflation (good news for the economy) may become a new subject of contention between hawks and central bank doves .
It may seem paradoxical, but a good part of the confrontations in the Governing Council of the ECB in recent years have occurred when the economy and inflation were gaining momentum. When the economic recession or deflation threaten the euro zone, the ECB acts almost seamlessly and forcefully (at least since Mario Draghi’s mythical whatever it takes ).
The problem and the discussions come when the moment approaches to withdraw ‘assisted breathing’ from the economy. While some want to remove it as soon as possible ( hawks ), others always find ‘excuses’ to keep bond purchases and rates in negative territory ( pigeons ).
Economists at Bank of America Merrill Lynch (BofAML) believe this will be the last quiet meeting of the ECB: “This week’s ECB meeting could be the calm before the storm . The outlook and balance of risks have hardly changed. , the ECB has delivered on its promise to buy more bonds . It is time to reiterate the messages. But we return to the previous topic: we hope that the ECB does not provide any additional guidance for the coming months, leaving room and time for market nerves before June meeting “. Some European bankers have already started talking about the end of the PEPP .
Inflation and growth
Inflation, even due to temporary factors, will continue to rise in the coming months. In Germany, the harmonized CPI has already reached 2%, a figure that ‘makes the German Bundesbank nervous’. On the other hand, this inflation boom will coincide with the expected economic recovery, which will generate optimism and allow the hawks to strengthen their argument to withdraw stimulus as soon as possible, even if bond yields rise faster as a result of higher growth. and expected inflation.
“Although the ECB has been more active in reversing higher long-term yields and tightening financial conditions, we believe they will be more open to these increases if they coincide with stronger economic data,” adds Mohammed Kazmi, macro strategist and UBP Fixed Income Portfolio Manager.
The central bank announced in March an increase in the pace of monthly bond purchases under the pandemic program (PEPP). The ECB is buying about 19 billion euros in bonds every week in a bid to cap the boom in debt yields. Since 2021 began, interest rates on debt have risen sharply, in part driven by the shock wave of growth and inflation expected in the US. These higher interest rates in Europe could hinder the recovery, which does not mean that if the economy begins to grow strongly in the euro zone, higher interest rates will have to be tolerated.
The debate within the ECB will end up arriving
From the Japanese bank Nomura they do not expect any policy change at the ECB meeting, but acknowledge that the most controversial decisions are yet to come: “The June meeting is still the next key event for the ECB, it is when the central bank will have to decide whether to keep PEPP purchases at current (ie higher) levels or start reducing them. Given our inflation forecasts and current financing conditions, we believe that the ECB will probably have to continue buying at the framework of its PEPP program at weekly rates similar to the current ones at least until September 2021 “.
The ECB still has margin because it has only spent just over a trillion of the 1.85 trillion that the total PEPP package has. However, Lagarde has repeatedly pledged to use only what is necessary, so leaving a portion of the PEPP unspent (net purchases) would temporarily appease the hawk wing. But everything will depend on how the economy and inflation behave .
“If the Next Generation (European recovery program) is launched on time and economies reopen, comments on the PEPP reduction will increase, markets will get nervous and they will probably try to find where the consensus is at the ECB when it comes to higher yields “, they assure from BofAML. When the recovery begins on a sustained basis, the ECB will welcome a slight rise in debt interest rates, as it will reflect the improvement in the economy. But that is when the most serious mistakes can be made, as happened in the opening of 2011, when the ECB raised interest rates and lit the fuse of a sovereign debt crisis that was close to ending the euro.
“You cannot rule out the risk of seeing a mistake by tightening monetary policy too much. However, if the uncertainty about the Next Generation (it is being reviewed by the German TC ) continues until then (and we believe that this is a real risk ), that could be enough to avoid a hard-line mistake in June. But this can only postpone the inevitable. Without a properly defined reaction, it would only be a matter of time before the market retested the ECB “, say the experts by BofA.