ECB announces contingent exit
The ECB surprised financial markets by sticking to its plans to head for the exit from its accommodative monetary policy settings, although it also stressed that it could move back in the other direction based on how the outlook would develop. Our main take away is that if the macro data follow the path it expects and financial conditions do not tighten significantly further, the ECB will stick to its plan to taper asset purchases, with a rate hike potentially following by around the turn of the year. However, there is a significant risk that the ECB’s exit plan will be knocked off course.
Exit plan could well be derailed
The ECB surprised financial markets by sticking to its plans to head for the exit from its accommodative monetary policy settings, although it also stressed that it could move back in the other direction based on how the outlook would develop. Our main take away is that if the macro data follow the path it expects and financial conditions do not tighten significantly further, the ECB will stick to its plan to taper asset purchases, with a rate hike potentially following by around the turn of the year. However, we judge that the ECB is too optimistic on growth, while there is a significant risk of tightening financial conditions and monetary policy fragmentation (indeed, Italian 10y government bond yields are up by more than 20bp on the day). Given this, there is a significant risk that the ECB’s exit plan will be knocked off course after all.
We set out the ECB’s main policy decisions below, as well as the main features of the ECB’s new projections and scenarios.
Key decisions
The ECB made a number of announcements in its policy statement this afternoon:
A quicker near term slowdown of APP: Monthly net purchases under the APP will amount to EUR 40bn in April, EUR 30billion in May and EUR 20 billion in June, compared to EUR 40bn in Q2 and EUR 30bn in Q3 and a monthly pace of EUR 20 billion for as long as necessary, in the previous statement.
Flexibility on the end of APP: The Governing Council stressed that the ‘calibration of net purchases for Q3 will be data-dependent and reflect its evolving assessment of the outlook’. 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 Q3. However, it also states that ‘if the medium term inflation outlook changes and if financing conditions become inconsistent with further progress towards the target, it stands ready to revise the schedule for net asset purchases in terms of size and/or duration’.
Rate hike timing data dependent: 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’. This seems to imply a longer period of time between the end of the APP and the first rate change than its previous guidance where it said that it ‘expects net purchases to end shortly before it starts raising the key ECB interest rates’. However, in the press conference, President Christine Lagarde signalled that the first rate hike was not time dependent but rather data dependent. Meanwhile, while its conditions for lift off remained unchanged, it did drop the explicit reference leaving open the possibility of a deposit rate cut.
Watching conditions for banks: As in February, the ECB also announced that it will assess the appropriate calibration of its two-tier system for reserve remuneration so that the negative interest rate policy does not limit banks’ intermediation capacity in an environment of ample excess liquidity. This leaves the door open for an increase in the tiering multiplier. In addition, the Governing Council will continue to monitor bank funding conditions and ensure that the maturing of operations under TLTRO III does not hamper the smooth transmission of its monetary policy. This suggests that signs of tightening funding conditions could see adjustments or extensions of this programme.
New projections
The base scenario of the ECB’s new staff macroeconomic projections includes a first assessment of the impact of the Russia–Ukraine conflict. It is based on the information available up to 2 March 2022, which was six days before the announcement of the EU’s REPowerEU plan to reduce EU demand for Russian gas by two thirds before the end of the year. The ECB has revised its forecasts for GDP growth in 2022 and 2023 lower, to 3.7% (from 4.2% in its December 2021 projections) and to 2.8% (from 2.9%), respectively. The forecast for growth in 2024 has remained unchanged at 1.6%, which is close to the trend growth rate. It seems that the ECB’s first assessment of the impact on economic growth of the Russia-Ukraine conflict is rather optimistic and our own first estimate is that growth will be reduced by around 1-1.5 percentage points due to the conflict. Compared to the December projections, the ECB’s projections for inflation in the base case has been revised significantly higher, to 5.1% (from 3.2%) in 2022, 2.1% (from 1.8%) in 2023 and to 1.9% (from 1.8%) in 2024. Core inflation (excluding food and energy) is expected to be 2.6% in 2022, 1.8% in 2023 and 1.9% in 2024. This implies that underlying inflationary pressures are expected to remain subdued in the current ECB base case, at a level somewhat the ECB symmetrical target of 2%. The central bank will publish a more extensive report on its March 2022 projections as well as two alternative scenarios on 11 March.