ECB to slow asset purchases amid improved growth outlook

Following its latest Governing Council meeting the European Central Bank (ECB) has kept main policy interest rates and various quantitative easing (QE) programmes unchanged.

The bank sounded upbeat over the prospects for the eurozone economy, as good progress in vaccinating the population has enabled the resumption of activity in many sectors. It was, however, less confident over the prospects of keeping inflation near or above target over the medium term.

The ECB sees inflation falling back below 2% in 2022, as most of the factors that have pushed up the current rate to 3% are likely to be transitory.

Overall, it would have sounded like another “much ado about nothing” meeting, except for the announcement about the pandemic emergency purchase programme (PEPP).

PEPP asset purchases are “to slow moderately” in the final quarter of the year. This is significant as not only is the US Federal Reserve (Fed) preparing to taper its asset purchases, but the ECB needs to decide what it will do with the PEPP when it is due to end in March 2022.

ECB president Christine Lagarde was keen to emphasise that the decision is not tapering, but a recalibration of the policy tool. Unlike the Fed, the ECB’s PEPP is not an open ended programme with monthly purchase targets.

Instead, it has an overall envelope for purchases, which can be used flexibly, within a certain timeframe. In late spring, the ECB announced it would accelerate its purchases to help with the second wave of lockdowns that hit the European economy.

However, in doing so, the bank effectively depleted its budget for purchases. So in a sense, the ECB was always going to slow the purchase rate if it had planned to maintain the programme through to next year.

Not slowing purchases would have required an active decision to increase the size of the stimulus package. This would have probably encountered loud opposition from Northern member states, which are facing much higher inflation.

Lagarde stated in the press conference that the Governing Council will make a decision on what to do with PEPP at the December meeting. But given the bullish outlook for the economy, it's almost a given that PEPP will end next year.

This means that QE, will fall from around €240 billion per quarter, to about €60 billion by the second quarter of 2022. The reduction is likely to lead to higher government bond yields (downwards price pressure), but for the wider economy, there will be a growing boost from infrastructure spending thanks to the Next Generation EU fund.

As for interest rates, the new higher inflation target and strict forward guidance for the necessary conditions to start the hiking process mean that we do not expect any hikes before the end of 2022.