ECB Confronts Global Rates Upheaval As German Inflation Soars

Over the past several weeks, traders began pondering active central banks and preemptive policy tightening in the face of surging inflation. Even the ECB was swept up in the global front-end rates upheaval.

Headed into Thursday’s October policy meeting, markets priced in as much as 20bps of rate hikes from Christine Lagarde and co. by the end of 2022.

At September’s meeting, the ECB attempted what I characterized as a “sorta taper.” The bank tipped a “moderately lower” pace of purchases under its pandemic QE program (PEPP) compared to the previous two quarters, a notable semantic shift given that during Q1’s global rates mini-tantrum, the bank employed language telegraphing a “significantly higher” pace of PEPP buying.

On Thursday, in the latest statement, the bank kept the “moderately lower” language and reiterated that “flexible” purchases “according to market conditions” and “across asset classes and among jurisdictions” is key when it comes to supporting “the smooth transmission of monetary policy.”

In the figure (below) you can clearly see when the ECB transitioned to a “significantly higher” pace earlier this year. That abated over the past two months.

Although the ECB continues to insist that PEPP’s full firepower (the “envelope”) need not be fully exhausted as long as financing conditions stay favorable, sources said this month that the bank is studying a plan to launch a new bond-buying program once the pandemic QE facility is wound down.

Of course, the pandemic program runs alongside “regular” QE, and any new plan to replace PEPP would aim to smooth the transition and prevent any market tumult as emergency purchases are phased out next year. As I wrote in “Do You Remember Snow?“, that plan, if carried out, essentially means PEPP would get a few tweaks, a new name and the ECB would keep running two QE programs simultaneously.

Earlier this month, Jens Weidmann resigned as Bundesbank President. In a letter to staff, he expressed something like consternation at the evolution of monetary policy and warned “it will be crucial… not to lose sight of prospective inflation risks.”

Data out Thursday showed inflation in Germany picked up to 4.5% in October and 4.6% on the harmonized gauge (figure below).

“There are a number of reasons for the high inflation rates since July 2021, which include base effects due to low prices in 2020,” Germany’s federal statistics office said. “In this context, especially the temporary value added tax reduction, had an upward effect on the overall inflation rate,” the color accompanying the release added, noting that “apart from the usual market developments, additional factors were the introduction of CO2 pricing as of January 2021 and crisis-related effects, such as marked price increases at upstream stages in the economic process.”

In the October statement, the ECB recapped the language detailing its new inflation framework, adopted earlier this year following a policy review.

“The Governing Council expects the key ECB interest rates to remain at their present or lower levels until it sees inflation reaching 2% well ahead of the end of its projection horizon and durably for the rest of the projection horizon, and it judges that realized progress in underlying inflation is sufficiently advanced to be consistent with inflation stabilizing at 2% over the medium term,” the bank said, noting that “this may also imply a transitory period in which inflation is moderately above target.”

Moderately.