Lagarde, Working From Home, Says It’s Dicey Out There

When it comes to the process of normalizing monetary policy, the ECB is “really very much” on the way, Christine Lagarde said Thursday, at her post-meeting press conference, held via video link from her house. (She’s recovering from a bout with COVID.)

If your assessment differs from Lagarde’s, you’ll be forgiven. After all, rates are still negative and the ECB is still buying bonds. Not only that, the bank is apparently crafting a standby facility to deploy in the event periphery spreads were to widen “too much” as stimulus is withdrawn.

Lampooning the ECB’s foot-dragging is an exercise in futility. For years, the threat of a Japan-style descent into deflation seemed real enough, and that informed the Governing Council’s plunge ever deeper down the accommodation rabbit hole. Price discovery in euro fixed income died long ago, and any sort of rapid exit from bond-buying risks a disorderly selloff in non-core sovereign debt and the return of price discovery in credit markets, which are distorted beyond all recognition.

What Lagarde means by normalization is a determination to stick with the plan unveiled at the ECB’s March meeting, when the GC formally accelerated the time table on winding down net purchases under APP, or “regular” QE, if you like. The April statement affirmed the plan. “The incoming data since its last meeting reinforce its expectation that net asset purchases under its asset purchase program should be concluded in the third quarter,” the bank said. PEPP, the pandemic QE facility, ended last month, although reinvestments will continue through 2024.

As a reminder that no one needs, inflation continues to surprise to the upside in Europe and the war made things worse. Adjusted for headline inflation, the depo rate is negative 8% (figure below).

Adjusted for core inflation, the policy rate is negative 3.5%.

Markets have been anxious to price in multiple rate hikes for 2022, but the ECB has promised to wind down APP first. The GC reiterated that commitment on Thursday. “Any adjustments to the key ECB interest rates will take place some time after the end of the Governing Council’s net purchases under the APP and will be gradual,” the statement read.

There was no word from Lagarde about the exact timing of APP wind down. She’s waiting for the new projections. The “some time” language from the statement could mean “next week” or several months — again, that’s following the conclusion of APP. The June decision, Lagarde remarked, will include “an element of judgment.”

Whenever rate hikes commence, the GC will preserve “optionality, gradualism and flexibility,” the statement reiterated. If you’re confused as to the timeline on all of this, think about it this way: Net asset purchases will end at some point after June. Once they’re concluded, the ECB is free to hike rates.

Hedge funds sold the euro following Lagarde’s press conference, albeit on low, pre-holiday volume. Two-year German yields retreated, bull-steepening the curve.

The bottom line: The ECB isn’t in a hurry. If March’s decision to proceed with normalization despite the onset of hostilities on NATO’s doorstep represented a win for the hawks, April’s meeting skewed dovish. There’s simply too much war-related uncertainty for policymakers to be comfortable taking a more aggressive stance.

That said, asset purchases will almost surely end mid-summer. Barring a dramatic deterioration in the growth outlook, the GC will want to clear the deck for liftoff later this year.

Beyond that, nobody knows anything. In the first paragraph of the new statement, the GC effectively abandoned any pretense to foresight. “The conflict and the associated uncertainty are weighing heavily on the confidence of businesses and consumers [and] trade disruptions are leading to new shortages of materials and inputs,” the statement said, adding that although “surging energy and commodity prices are reducing demand and holding back production, how the economy develops will crucially depend on how the conflict evolves, the impact of current sanctions and possible further measures.”

Lagarde did say that any decision on the part of European lawmakers to “abruptly” impose a boycott on all Russian energy supplies would have a “significant” effect on the bloc’s economy.