The European Central Bank is all but certain to dial back its stimulus one more notch today while pledging to keep supporting the financial system next year, sticking to its long-held view that alarmingly high inflation will abate on its own.
With the euro zone’s economy now back to its pre-pandemic size, pressure is mounting on the bank to follow its global peers in turning off the money taps.
But policymakers are also fearful that stepping back too quickly could unravel years of work to rekindle once anaemic inflation.
The ECB’s dilemma is further complicated by an unusually uncertain outlook, which could force rate-setters to delay many of their big decisions until the new year, leaving policy exceptionally flexible with limited commitments.
The compromise is likely to be clarity on the framework of ECB policy in 2022, with details to be filled in as policymakers gain confidence that inflation, now running at more than twice the bank’s 2% target level, comes down quickly in 2022.
What appears certain is that bond buys under a €1.85 trillion Pandemic Emergency Purchase Programme will be reduced next quarter then wound down at the end of March.
A long-running Asset Purchase Programme, however, will be ramped up, compensating for some of this lost stimulus.
Still, overall purchases could be left at around €40 billion a month, less than half of the current buying, a Reuters poll of analysts showed.
The effective cut in stimulus could be much smaller though as fresh government debt issuance is expected to fall, so the ECB will continue to hoover up most of the new debt.
The ECB is also likely to signal that it will keep buying bonds throughout the year, in a bid to keep yields in check and to rule out any rate hike in 2022.
Beyond that, a plethora of options remain on the table.
The problem is that while the ECB will project inflation falling back under target in 2023 and holding there in 2024, a number of policymakers doubt this narrative, warning that even if driven by one-offs, high price growth could get stuck.
“It makes sense not to provide the parameters of the new asset purchase programme. They could provide the general principles but delay an announcement on the calibration and exact volumes,” said Luigi Speranza, chief global economist at BNP Paribas.
The US Federal Reserve’s signal last night that it would end pandemic-era bond purchases in March and raise rates three times next year also complicates life for the ECB, as the world’s two biggest central banks are now moving in opposite directions.
The most likely option is that ECB policymakers approve a bond purchase quota or “envelope” for 2022 and emphasise that not all of this must be spent.
The bank will then regularly review the exact volumes and set purchase targets only for short periods, much like it did in recent months.
It is also likely to increase its spending on supranational debt to support Next Generation EU spending, the bloc’s flagship project to aid the recovery.
The biggest risk is that investors start dumping bonds from the bloc’s indebted periphery, increasing the premium governments there need to pay to borrow.
To mitigate this risk of fragmentation, the ECB could say that the roughly €100 billion left in the emergency programme could still be used in case of market turbulence and cash from maturing bonds may be used flexibly, so the ECB could spend more in stressed markets.
The ECB will also have to address the issue of Greece, which is likely to drop out of bond purchases once the emergency programme ends.
While all options face legal hurdles, the ECB is likely to signal that reinvestments may be skewed towards Greece while it remains ineligible for new buys.
“Rarely has the backdrop for a major ECB decision been as uncomfortable and as uncertain as it is now,” Berenberg said in a note to clients.