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Hawks forced ECB to expand the scale of buying bonds despite the increasing Covid wave


Since the coronavirus pandemic hit Europe last year, conservative policymakers at the European Central Bank have put their annoyances aside with extremely loose monetary policy to stand by. after the economy affected by the regional crisis.

But even as the continent remains mired in increased infections, hawks are urging the central bank to prepare to scale down its massive bond-buying program.

This potential change, which risks splitting the ECB management board and destabilizing investors in the euro zone bond market, is expected to be discussed at the policy meeting. the bank’s currency on Thursday, though any action will be unlikely before the next meeting in June.

As the eurozone plunged into a record post-war recession last year, economists praised the ECB for scaling up its bond purchases with its emergency bond purchase program. PEPP), which helps to reduce borrowing costs for governments, businesses and households. .

Having twice scaled up its emergency bond purchase plan last year, the ECB still has nearly half of its 1.85 billion euros left to spend under the PEPP. It plans to continue net buying until at least March 2022 and only to cease when the pandemic crisis ends.

However, though euro zone economy still weighed down by rising Covid-19 infections and containment measures, more belligerent ECB board members are opting that they should start refraining from their bond purchases sooner. is later.

“Emergency monetary policy measures are not allowed to last indefinitely,” said Jens Weidmann, head of Germany’s central bank. told journalists in Frankfurt two weeks ago. “They need to maintain a strong relationship with the crisis and end when the pandemic ends.”

Klaas Knot, head of the Dutch central bank, went further a few days later, saying that if inflation and growth improve as expected from the second half of this year, then “from the third quarter. onwards, we may begin to gradually eliminate the urgency of a pandemic. purchase and finish them as scheduled by March 2022 ”.

At the last ECB monetary policy meeting, council members all agreed to buy PEPP at “significantly higher rate” in the second quarter to avoid sell-offs in the bond market. Borrowing fees are up before the recovery takes place.

But since then, its weekly net buying has only increased slightly, leaving analysts scratching their heads and wondering if the recent rally in the sovereign bond market is causing ECB officials to falter. think second or not.

Frederik Ducrozet, strategist at Pictet Wealth Management, said the ECB hawks “only agree to these previous bond purchases provided they are reduced in the third quarter and the PEPP is not expanded again. again” .

With the ECB releasing new economic forecasts in June, the forecasts expected by hawks to reflect a brighter outlook for growth and inflation, they identified that month’s meeting as a chance. to promote the reduction of bond buying scale.

Most economists consider the debate too early, especially that euro zone output is not expected to rebound to pre-pandemic levels next year and is still lagging behind most. Other major economies.

“These are test balloons that are floating to see the market’s reaction,” said Katharina Utermöhl, an economist at Allianz. “But it is strange that the ECB continues to discuss this at a time when we are lagging far behind the US, and even there the Federal Reserve is still pushing back any proposals for cuts.”

The hawks have long been a minority in the ECB council and will likely have a solid resistance to the idea of ​​cutting bond purchases too soon. Christine Lagarde, president of the ECB, said last week that financial and monetary support will “be needed for a recovery”.

Most analysts believe that Europe can hardly repeat the “anger” that caused the sell-off in the US Treasury market in 2013 after the Fed announced plans to reduce the volume of buying bonds.

The main reason is that the ECB has no plans to terminate bond purchases entirely next year. Instead, they are expected to expand their traditional asset purchase program, which continues to buy 20 billion euros of bonds per month and has increased by nearly 3 billion euros since 2015.

The main drivers of inflation in the euro zone

François Villeroy de Galhau, governor of Banque de France and ECB council member, said this month that the end of the PEPP will “not imply sudden tightening of our monetary policy” as the traditional asset purchase program will continue and may “be partially adjusted”.

Ducrozet at Pictet said the ECB will also continue to reinvest money from maturing bonds in its 1.85 billion euro PEPP portfolio over the next few years – providing additional stimulus. “The market can handle the exit from PEPP,” he said, pointing out that government debt issuance is expected to decline from its recent highs next year, meaning that the ECB will have fewer purchases. .

However, the worry for the ECB will be if inflation continues to rise sharply, forcing it to tighten policy even as the eurozone’s economic recovery stalled and borrowing costs rise for governments are most indebted.

Maria Demertzis, deputy director of Brussels-based consultancy Bruegel, said: “If inflation comes back on a sustained return, it will put the ECB in a very difficult position because we are still in the process. is in a very weak recovery state and it will place more dependence on fiscal policy with the risk of increasing financial market fragmentation ”.

Having dropped below zero in the last months of last year, euro zone inflation has risen to 1.3% in recent months and the ECB is expected to surpass its target of just under 2% in the final quarter of this year, albeit only temporarily.

The ECB says inflation is being pushed up by one-off factors and is expected to gradually decline next year. But German inflation is expected to rise above 3% this year, and Weidmann recently warned that “we may face stronger inflationary forces again in the future”.

Before the potential war awaits, Director of Bank Bundesbank said: “There is indispensable determination, even when increasing interest rates increase borrowing costs of countries. This has important implications for the reliability of monetary policy ”.

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