ECB to exit pandemic QE programme as inflation soars

The European Central Bank has decided to scale back its huge crisis stimulus, announcing its €1.85tn pandemic-response programme will end net purchases in March, but also promised to keep buying bonds for much of next year under a separate scheme.

The central bank said on Thursday that its Pandemic Emergency Purchase Programme (PEPP), launched last year to counter the financial impact of the coronavirus crisis, would lower its pace of net purchases in the first quarter of next year and then halt them in March.

But the ECB cushioned the impact by announcing it would expand its older asset purchase programme (APP) from its current monthly pace of €20bn to €40bn in the second quarter and to €30bn in the third quarter.

These purchases would continue at €20bn per month after October “for as long as necessary to reinforce the accommodative impact of its policy rates”, it said. The moves mean it will continue bond purchases but at a rate well below the near-€90bn a month it has operated for much of 2021.

Carsten Brzeski, head of macro research at ING, called the decision “a very cautious taper”.

“The governing council judges that the progress on economic recovery and towards its medium-term inflation target permits a step-by-step reduction in the pace of its asset purchases over the coming quarters,” the ECB said in a press release on Thursday after its governing council met virtually and decided to keep its deposit rate unchanged at minus 0.5 per cent.

The ECB postponed some decisions — including whether to reduce the attractiveness of subsidised loans to banks from next June — due to uncertainty over how the recent surge in coronavirus infections and the spread of the Omicron variant will affect growth and inflation.

It also maintained the possibility of restarting net purchases under the PEPP, if needed, to respond to any “negative shocks related to the pandemic”.

The reinvestments of maturing bonds already purchased under the PEPP would be extended until at least the end of 2024 and “adjusted flexibly across time, asset classes and jurisdictions at any time” to allow it to skew these towards Greek bonds, which it is otherwise prevented from buying due to their low credit rating.

The ECB also raised its inflation forecasts for the next few years, predicting it would increase from 2.6 per cent this year to 3.2 per cent next year. But it continued to predict that price growth would then fall below its target to hit 1.8 per cent in 2023 and stay at that level in 2024.

It said on Thursday that “monetary accommodation is still needed for inflation to stabilise at the 2 per cent inflation target over the medium term”, while stressing the need to “maintain flexibility and optionality in the conduct of monetary policy”.

Christine Lagarde, ECB president, said restrictions introduced in response to a surge in coronavirus infections had “moderated” the region’s economic growth in the final quarter of this year.

She added that this slowdown had delayed by several months the expected recovery of the eurozone economy to its pre-pandemic level until the first quarter of next year. The ECB lowered its growth forecast for next year to 4.2 per cent but raised it to 2.9 per cent for 2023.

The move to halt the expansion of the ECB’s emergency bond purchase scheme was widely expected by analysts. It reflects the recent rise in eurozone inflation to its highest-ever level of 4.9 per cent in November, well above the central bank’s 2 per cent target.

However, it contrasts with a more aggressive shift by the US Federal Reserve, which on Wednesday said it would speed up its “tapering”, or withdrawal of asset purchases, and signalled plans to raise interest rates next year.

In a busy day for the central banks of developed economies, the Bank of England also unexpectedly lifted borrowing costs by 15 basis points to 0.25 per cent on Thursday, while Norway’s central bank raised interest rates in a widely expected move by 25bp to 0.5 per cent. The Swiss central bank, meanwhile, kept its main interest rate unchanged at minus 0.75 per cent.

“While this falls well short of the ‘full taper’ which the Fed has now stepped up, it is still a big reduction in policy support,” said Andrew Kenningham, an economist at Capital Economics. “The commitment to subsequently reduce the APP to only €20bn per month [by October] is a touch more hawkish than we and perhaps the markets had anticipated.”

Eurozone government bonds, which had already slipped following the BoE’s rate increase earlier on Thursday, fell further following the ECB announcement.

Germany’s 10-year yield climbed 0.04 percentage points to minus 0.33 per cent. Italian 10-year borrowing costs were 0.07 percentage points higher at 0.98 per cent. The decision to skew PEPP reinvestments towards buying Greek bonds led to a milder sell-off in Greek government debt, with yields only marginally higher. Bond yields rise when prices fall.

The euro rose 0.4 per cent against the dollar to $1.134, its highest point in a week.

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