European Central Bank (ECB) policymakers were set to gather on December 16 for a crunch meeting, as soaring inflation heaps pressure on the bank to wind down its stimulus just as a new coronavirus variant threatens to derail the recovery.
The Frankfurt-based institution is expected to confirm the planned end of its massive pandemic-era stimulus plan in March, currently hoovering up around €70 billion ($78 billion) worth of assets every month.
The €1.85-trillion pandemic emergency bond-buying programme (PEPP) is the ECB’s main crisis-fighting tool, aimed at keeping borrowing costs low to stoke economic growth.
The challenge for the ECB’s 25-member governing council is finding a way to smooth the transition to avoid upsetting markets or jeopardising the eurozone’s fragile rebound from the initial coronavirus shock.
Boosting the bank’s pre-pandemic asset purchase programme (APP), currently running at €20 billion a month, or creating a new envelope for financial support through 2022 and beyond are two of the options discussed by observers.
The ECB will want to avoid a “cliff-effect” in asset purchases and would settle on an overall rate “between €40 and 60 billion” in the second quarter next year, said Pimco portfolio manager Konstantin Veit.
Last month, prices rose 4.9 per cent year-on-year in the eurozone, a record in the history of the single currency.
While the ECB has up to now described the spike as “transitory”, attributing it to one-off pandemic related factors, inflation has progressed at a rate that has exceeded observers’ expectations.
The emergence of the more contagious Omicron variant has raised fears of more pandemic-related disruption, aggravating supply bottlenecks that have pushed prices up faster and hampered economic growth.
Alongside its monetary policy decisions, the ECB will publish its latest set of economic forecasts, including its first set of figures for 2024.
Last updated in September, the bank expected the economy to grow by five per cent in 2021, 4.6 per cent in 2022 and 2.1 per cent in 2023.
On the inflation side, price rises were expected to be 2.2 per cent in 2021 for the whole year, before dropping under the ECB’s two-per cent target for the next two years at 1.7 and 1.5 per cent.
Recent pressure on prices could lead to “the largest ever upward revision to inflation in 2022, from 1.7 to 2.7 per cent”, according to Frederik Ducrozet, strategist at Pictet Wealth Management.
The focus will be on the new number for 2024, said Andrew Kenningham of Capital Economics, “the nearer this is to two per cent, the closer the bank will be to raising rates”.
But a lower figure could allow ECB president Christine Lagarde to continue to argue that the spike was a passing phenomenon in a press conference at 1430 local time (1330 GMT), paving the way for a more gradual easing of economic support.
Across the Atlantic, where the rise in inflation has been even steeper, the US Federal Reserve (Fed) announced that it was doubling the pace of its withdrawal from asset purchases, bringing the end forward by several months.
Fed officials dropped talk of “transitory” inflation as figures for November showed a 6.8 per cent year-on-year rise.
Policymakers at the central bank also indicated that they expected the Fed could raise its interest rates up to three times next year.
But the possibility of the ECB following suit still seemed distant, despite expectations in some corners of the market that the ECB will tighten its monetary policy more quickly.
Lagarde previously said it was “very unlikely” the ECB would raise its rates in 2022 from their historic lows, including a negative deposit rate that means lenders pay to park excess cash at the central bank.
Currently, the bank plans to end its asset purchase programme fully before moving on to rate hikes.
But even the most accommodative of responses from the governing council in the short term, extending its asset purchases under any guise, “should also leave the ECB with the possibility of earlier, and larger hikes”, said Antoine Bouvet, a strategist at ING.