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The ECB Tightens its Embrace of Unconventional Monetary Policy
- By Katharine Neiss, PhD, Chief European Economist, Global Macroeconomic Research
- December 10, 2020
What a difference a year—and a pandemic—makes. When former ECB President Draghi announced a restarting of quantitative easing in September of last year, he faced what was described as a “chorus of criticism” that revealed deep divisions within the policymaking Governing Council. This was despite the fact that inflation was on a continued downward trajectory and that the ECB’s own projections pointed to below target inflation in the medium term. Quantitative easing looked to have gone beyond its political limits, and outside observers were beginning to question the central bank’s credibility and commitment to its mandate.
Fast forward to today: we have a new President at the helm of the ECB and a Governing Council that looks to have embraced unconventional monetary policy to tackle the economic impact of the pandemic. The ECB’s latest decision—to extend its pandemic emergency purchase programme by a further €500 billion until at least March 2022 and enhance the favourable terms of its targeted long term refinancing operations—follows a succession of such decisive actions over the course of this year. It brings the total envelope of emergency asset purchases to €1.85 trillion, equivalent to about 15% of euro area GDP. If used in full, it suggests an average monthly run rate of €70 billion in asset purchases (Figure 1) that are expected to push up meaningfully on GDP and inflation at the two- to three-year horizon. There are a number of good reasons underpinning the ECB’s latest action.
Figure 1: Pandemic Emergency Purchase Programme
First, despite the good news of the Q3 GDP bounce-back and vaccine breakthroughs, the euro area economy is showing clear signs of weakening as it struggles to contain a second wave of the virus. Real time indicators point to a contraction in Q4 GDP, and with social distancing restrictions likely to be extended into the early part of next year, it’s possible that the region could see a double dip with two consecutive quarters of negative growth. Against an uncertain political backdrop due to ongoing Brexit and EU budget negotiations, this has put more pressure and focus on the central bank to act.
Second, the extension of the PEPP now mirrors the expected roll out of the vaccine and return to normality. In recent months, health authorities in the region have been actively managing expectations with regard to a vaccine rollout. In particular, once a vaccine has been approved, it is likely to be limited in supply with insufficient doses for the entire population before the end of 2021. Moreover, throughout the vaccine rollout stage, social distancing is expected to continue to serve as a key tool to control and manage outbreaks. President Lagarde’s statement noted that “it will take time until widespread immunity is achieved, while further resurgences in infections, with challenges to public health and economic prospects, cannot be ruled out.” And during the Q&A she noted that herd immunity would unlikely be achieved before the end of 2021. In light of this timeline, the ECB’s extended emergency pandemic purchase programme offers a degree of certainty that credit will continue to flow to the real economy as the region manages this “bridging” phase of the crisis.
Finally, significant policy easing is needed in order to halt the slow, downward grind of inflation that predates the pandemic and risks de-anchoring expectations to the downside—a particularly worrying prospect given sharply rising debt levels across the region. In that regard, it is notable that in her latest press briefing, President Lagarde mentioned inflation more times than in previous press conferences (Figure 2), as well as specifically expressing concern about the impact of the euro’s appreciation on inflation.
This renewed focus on inflation that is seen to be “disappointingly low” is welcome but will need to be reinforced when the ECB publishes its monetary framework review in 2021. To that end, the new year stands to be another transformative period for the ECB.
Figure 2: Mentions of Inflation in the ECB Introductory Statement
This material reflects the views of the author as of December 10, 2020 and is provided for informational or educational purposes only. Source(s) of data (unless otherwise noted): PGIM Fixed Income.
Katharine Neiss, PhD
Katharine Neiss, PhD, is a Principal and Chief European Economist for PGIM Fixed Income, based in London. Ms. Neiss covers the macro-economic outlook in the UK and euro area, including Bank of England and ECB policy. Prior to joining the Firm in 2020, Ms. Neiss was Head of the International Surveillance Division at the Bank of England, responsible for briefing policymakers on the global macro-economic and financial stability outlook. Previous roles at the Bank of England include Head of the Policy, Strategy and Implementation Division, covering regulation of major UK banks, and senior manager roles in the Structural Economic Analysis Divisions, covering the UK economy. Ms. Neiss has published several articles in peer reviewed academic journals on topics ranging from real interest rates as a monetary policy tool and the impact of the global financial crisis on supply. She received a BA Honours in Economics from Queen’s University and holds a Masters and PhD in Economics from the University of British Columbia.
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