“Inflation is likely to remain elevated longer than previously expected but will decline in the course of this year,” Christine Lagarde said Thursday, during remarks following the ECB’s February policy meeting.
The statement contained no surprises. Net asset purchases under PEPP will cease next month, but principal payments from maturing bonds in the portfolio will be reinvested “at least” through the end of 2024. The bank noted that “the future roll-off of the PEPP portfolio will be managed to avoid interference with the appropriate monetary policy stance.”
As for “regular” QE, it’ll run at a €40 billion per month pace starting in Q2, with a step down to €30 billion in Q3 and €20 billion (the longstanding monthly pace) from October. There’s no end date on those purchases. It’s perpetual QE. The language just says “for as long as necessary.”
Reinvestments of principal payments from APP will continue “for an extended period” beyond the first rate hike — assuming there is one. (I’m reminded of Phil Connors on this Groundhog Day week: “Well what if there is no tomorrow? There wasn’t one today!”)
All of that was in-line with December’s decision.
Currently, realized inflation is making a mockery of the ECB’s rates guidance — and economists’ forecasts. January’s headline print was the highest in history and the beat versus consensus the largest on record in Bloomberg data going back two decades. The figure (below) is highly amusing.
“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 statement reiterated, noting that “this may also imply a transitory period in which inflation is moderately above target.”
There it is. That word again. “Transitory.”
But Lagarde seemed acutely aware Thursday that the ECB risks perpetuating the idea that policymakers are deluding themselves — deliberately persisting in a policy bent that’s no longer congruent with reality.
“We do assess risks to the upside for the near-term — particularly for the near-term,” she said. “In March, when we have additional data, when we’ve been able to integrate in our analytical work the numbers we’ve received in the last few days, we will be in a position to make an assessment.”
That was a tacit admission that the March forecasts could betray a BoE-style upward revision.
“There was unanimous concern around the table of the Governing Council about inflation,” Lagarde went on to say. The ECB, she remarked, is getting “much closer” to reaching its target.
All of that was hawkish. You need to consider the source. This is the ECB. Prior to the pandemic, Europe was widely viewed as being well on the way to joining Japan in a deflationary quagmire from which there’s no escape. That risk didn’t disappear with COVID, and policymakers are extremely wary of taking steps that might chance a speedy return to disinflation once pandemic distortions fall away.
And yet, the ECB is plainly concerned. Lagarde’s Thursday remarks raised the odds of a decisively hawkish pivot. Such a shift would mark the realization of a tail risk. She didn’t repeat a favorite phrase indicating a 2022 rate hike is unlikely.
Money markets priced in 40bps of ECB rate hikes for 2022 as Lagarde spoke, with a 10bps increase seen in June. Five-year German yields surged 12bps. The BTP-bund spread ballooned wider. Concurrently, “hedge funds flood[ed] the short-end of the Treasury curve with sales,” as Bloomberg’s Alyce Andres put it.
Later, reports indicated the GC decided it was “sensible” not to rule out a hike in 2022. It’s possible, policymakers reportedly agreed, that net APP purchases could end in the third quarter. The March meeting just became very important.
