The ECB faces some tricky policy decisions and judging by the minutes of the last meeting the Governing Council has no clear view on how to proceed. The euro zone economy has surprised to the upside this year, bank credit across the zone is growing again, the redenomination risk in sovereign bond markets has long gone and the unemployment rate has fallen to 9.1% from a peak of over 12% , all of which might argue for a change to policies born in a crisis environment or adopted when deflation was perceived as a real danger.
Yet the ECB”s (self-imposed) goal remains elusive- inflation is not ‘close to but below 2%’ and according to the current staff forecast that will remain the case for some time, with an average of 1.5% projected for 2019. Indeed, according to the minutes, some council members questioned whether the staff had used an appropriate pass-through rate from the euro’s recent appreciation and hence wondered if the inflation forecast was actually too high.
The minutes also revealed ‘discomfort widely expressed’ about the length of time inflation had been and was expected to remain below target, and that ‘a very substantial degree of monetary policy accommodation was still needed for inflation to converge sustainably to levels in line with the Governing Council’s aim’, which would imply that we are unlikely to see a substantial policy shift in the near trem. Indeed, ‘any reassessment of the monetary policy stance should proceed in a very gradual and cautious manner‘.
So what are the options?. Policy as it stands includes the purchase of €60bn assets a month until the end of December this year ‘or beyond, if necessary‘. The minutes would indicate an abrupt halt in a few months is out of the question but there are logistical issues in a number of countries, given the current 33% issuer limit on sovereign bonds. Consequently, the market is anticipating some form of ‘tapering’, and the minutes discussed the merits of continuing to buy for a longer period but at a slower monthly pace against a higher monthly volume over a shorter time frame.
The former is perhaps more likely, as it better ties in with another strand of policy, a commitment to keep interest rates at current levels for an extended period and ‘well past the horizon of the net asset purchases’. This explicit linking of forward guidance on rates to QE argues for extending the latter for a longer period if the ECB wants to influence rate expectations and that might indeed have an additional impact, this time on the exchange rate. We know the Bank is concerned about the currency’s appreciation, and if one rules out explicitly talking it down one lever left is to convince markets that rates will stay lower for longer.
The ECB will also no doubt emphasise that it intends to keep reinvesting the proceeds of maturing assets but the net asset decision will be key, and lower for longer may well be the mantra that decides the latter.