ECB View: Officials take different view of ‘crisis period’ – A number of ECB Governing Council members spoke yesterday, with differences in their views on the policy outlook appearing. More hawkish officials are signalling an end to PEPP in Q1 of next year and a tapering before then. This reflects the view that at this point the crisis period will be over. More dovish officials defined the end of the crisis as being when the output gap closes (which will take much longer).  They stress the need for ongoing policy support. This does not necessarily mean an extension of the PEPP, but a continuation of the APP with more flexible conditions. Below we set out the comments in more detail.

To start with the hawks, Bundesbank President Jens Weidman signalled that PEPP ‘must be ended as soon as the emergency situation has been overcome’ and that ‘two prerequisites are that pandemic-linked restrictions should have been lifted and that the economic recovery is solid’. In his view ‘economic output in the euro area should exceed its pre-crisis level in the first quarter of 2022’ and hence ‘2022 would no longer constitute a crisis year’. Robert Holzmann, the Governor of the central bank of Austria also hinted at early 2022, saying that ‘once the emergency is over, the programme ends’.

On the dovish side of the spectrum, Governor of the central bank of Spain Pablo Hernandez de Cos, noted that the ‘ECB is forecasting a recovery to pre-crisis GDP in the first part of 2022, but perhaps that’s not the most appropriate reference in terms of when we will be able to say the crisis has come to an end’. Instead, in his view ‘the goal has to be to recover – not the levels before the crisis – but those we would have reached without the existence of this crisis’ and ‘even in 2023, the pre-crisis trajectory won’t have been reached’. This outlook was ‘important in terms of the evolution of economic policy’. Meanwhile, ECB Executive Board member Fabio Panetta suggested that whether the PEPP ends or not, its flexibility should now become a regular feature of asset purchases’ (hence in the APP). He noted that ‘what was seen as unconventional in the past is now conventional. In particular, the pandemic emergency purchase program has shown the benefits of flexible monetary policies when differences in financing conditions across countries represent a persistent obstacle to the transmission mechanism’.

Our view is that the September Governing Council meeting will be a significant one for the ECB. The central bank will likely announce the outcome of its strategy review. One of the key elements of that review will be a more ambitious inflation target (symmetry around 2%). Therefore, the gap between its projection of inflation and its inflation goal will be larger. At the same time, it is likely to give a stronger signal that the PEPP will indeed likely end in March 2022 and will therefore have a challenge to manage market expectations that an end to the PEPP will not lead to early rate hikes. The ECB could push back against these expectations by strengthening its forward guidance. This can be done by signalling much more explicitly that policy rates will remain on hold for a much longer period than markets expect. Alternatively, it could send the same message indirectly by signalling a much longer period of net purchases under the APP beyond (and perhaps with more flexibility and volume than currently) when the PEPP ends in March 2022.