Boxed in by the highest inflation on record and the (assumed) impossibility of pivoting aggressively hawkish amid the most serious security threat in Europe since World War II, the ECB was expected to do nothing on Thursday. Or mostly nothing, anyway.
Recall that Christine Lagarde pivoted hawkish at February’s meeting, ostensibly setting up the first baby steps towards normalization. But Russia’s invasion of Ukraine was seen ruling out any overt nods to an accelerated pace of policy tightening.
Apparently, though, the threat of a persistent inflation overshoot (figure below) was deemed sufficiently serious to warrant a hawkish lean.
As flagged for months, net purchases under the bank’s emergency pandemic QE program (PEPP) will be wound down in March, and proceeds from maturing securities reinvested through end-2024. The new statement kept the language around the possibility of using PEPP reinvestments to support Greek bonds. “In the event of renewed market fragmentation related to the pandemic, PEPP reinvestments can be adjusted flexibly across time, asset classes and jurisdictions at any time,” the ECB reiterated.
But the hawkish “surprise” came from a formal acceleration of the time table on winding down net purchases under APP or “regular” QE, if you like. The ECB will buy €40 billion in April, €30 billion in May and €20 billion in June. After that, “the calibration of net purchases… will be data-dependent,” the statement said, adding that “if the incoming data support the expectation that the medium-term inflation outlook will not weaken even after the end of our net asset purchases, the Governing Council will conclude net purchases under the APP in the third quarter.”
That was unambiguously hawkish in the current context. Were it not for the conflict in Ukraine, markets likely would’ve expected just such a formal pull-forward. That the ECB went ahead with it despite spiraling geopolitical tensions suggested the war didn’t alter the bank’s decision calculus when it comes to the necessity of accelerating the end of net purchases, which, you’re reminded, need to be wound down before rate hikes can commence.
The ECB also jettisoned language that suggested rates could be cut. “In light of the stagflation risk and high uncertainty, this decision gives the central bank maximum flexibility and keeps the option open for a rate hike before year-end,” ING remarked.
Italian yields surged following the announcement, rising more than 20bps, indicative of just how tenuous the situation really is in the periphery, where no one really knows what “fair value” is absent the ECB backstop. Bunds sold off too, with knock-on effects for Treasurys ahead of US CPI data. European shares extended losses.
This is a perilous time for the ECB. Clearly, the conflict raises the odds of a sustained inflation overshoot, but it also imperils the growth outlook. The new projections are so stale as to be meaningless.
The ECB did nod to Ukraine, though — in the very first sentence of the new statement, no less. “The Russian invasion of Ukraine is a watershed for Europe,” the Governing Council said, expressing “full support to the people of Ukraine.” The ECB pledged to “ensure smooth liquidity conditions” and promised to “take whatever action is needed” to fulfill its mandate and safeguard financial stability.
The problem, at present, is that the measures needed to ensure price stability may not be consistent with what’s needed to promote “stability” in a more general sense of the term.
This is anecdotal but from what I am hearing- German automobile makers are shutting down assembly lines a few days/week due to parts which are normally assembled in Ukraine, not being available.
Car prices won’t be dropping anytime soon.
I have heard a similar story from one of my sources as well, although he added that in most cases car manufacturers have diversified the sourcing, so this is only very temporary.
I’m interested in the correlation with Japan, actually, the potential post pandemic mindset. The Hawks have essentially courted the concept that airborne coronavirus was fake news and that economies needed to be fully open. The exaggerated panic to get everything back to normal in a V recovery remains their wet dream fantasy. Ignoring weak recovery data and smoothing over all the nonlinear abnormal distortions of the last three years doesn’t add to stability.
It’s interesting to have a counterbalance perspective from Japan:
“such a rise in inflation alone would not be reason to dial back stimulus, Nakagawa said, adding that Japan’s economy was still in the midst of recovering from the pandemic’s wounds.”