By Konstantin Veit, Portfolio Manager at PIMCO
- Elevated uncertainty around the macroeconomic outlook will lead the ECB to focus on policy optionality.
- We expect the ECB to revise upwards its quarterly inflation projections and to retain openness to an earlier end of net asset purchases compared to the plan laid out in December, once the current crisis has abated.
- We do not expect the ECB to formally announce a firm end date or material recalibration of their Asset Purchase Programme (APP) at the March meeting, as the worsened geopolitical backdrop clouds visibility and leads to a reassessment of the growth outlook.
- Over the medium term, we believe the ECB will certainly aim for ending net asset purchases and get back to a zero policy rate, with little ambition beyond that.
- Over the longer term, there remains considerable uncertainty where a neutral policy rate for the Euro area might be, but anything between 0% and 1% seems reasonable in comparison to other jurisdictions.
Asset purchases and interest rates:
In December the Governing Council put forward its plan for the exit from the pandemic crisis-related asset purchase configuration, back towards the pre-Covid €20 billion open-ended net asset purchases per month. The ECB confirmed it will discontinue net asset purchases under the Pandemic Emergency Purchase Programme (PEPP) at the end of March 2022 and, to avoid a cliff-effect, it decided on a monthly net purchase pace of €40 billion in Q2 and €30 billion in Q3 under the regular APP. From Q4 2022 onwards, the Governing Council planned to maintain net asset purchases under the APP at a monthly pace of €20 billion for as long as necessary, which essentially represents the pre-pandemic monetary policy configuration.
Inflation developments post the December meeting came in considerably above expectations, and the new March macroeconomic staff projections will certainly feature higher inflation numbers compared to December. In addition, the schedule for the March staff projections exercise has been revised in order to take into account the implications of the latest geopolitical developments, and also means that the February flash inflation release will be incorporated in the projections. In December, the ECB projected inflation at 3.2% for 2022, and 1.8% for 2023 and 2024. The 2022 number will certainly see a meaningful upward revision, the 2023 print might come in slightly above 2%, with the 2024 projection probably broadly unchanged. Core inflation at the end of the forecast horizon will likely remain below 2%, and risks to the inflation outlook tilted to the upside.
On the back of increased geopolitical risks, the ECB will also materially lower its growth projections and will probably characterize the risks to the economic outlook as to the downside, instead of broadly balanced. We expect the ECB to retain openness to an earlier end of net asset purchases compared to the plan laid out in December, once the current crisis has abated, but we do not expect the ECB to formally announce a firm end-date or material changes to their APP at the March meeting. Along the lines of regaining policy optionality, the ECB might decide to remove the word “shortly” from its APP forward guidance, to break the quasi-automatic temporal link between the two instruments. Optionality here implies that the policy rate lift-off could possibly take more time after the end of net asset purchases, if warranted. The ECB might also remove the reference to lower policy rates in its forward guidance on interest rates, although that could come somewhat later when the ECB gets closer to raising interest rates.
Over the medium term, we believe the ECB will certainly aim for ending net asset purchases and get back to a zero policy rate, with little ambition beyond that. Over the longer term, there remains considerable uncertainty where a neutral policy rate for the Euro area might be, but anything between 0% and 1% seems reasonable in comparison to other jurisdictions.