If you are waiting for the imminent end of central bank bond buying, “quantitative easing,” make sure you are seated comfortably. The European Central Bank could throw another $ 1 trillion log on the fire as soon as this week.
When interest rates on government loans plummeted around the world this week and stocks shuddered, markets seemed to rethink long-held assumptions about an end to pandemic closings, scorching economic rebounds and widespread reflation.
This month’s COVID headlines have certainly given investors a lot to think about, even if a complete rethinking of vaccine-driven recoveries still seems unnecessary.
But possible signals from Thursday’s ECB policy meeting could be just as to blame for the gloomy reading on global bonds. Another wave of post-pandemic bond buying in Europe seems likely, inevitably spilling over into other markets, even as other central banks begin to phase out emergency stimulus related to COVID.
Like the Federal Reserve did last year, the ECB this month announced changes to its long-term strategic objectives earlier than many expected. Although it did not quite mimic the Federal Reserve’s move to averaging its inflation target over time, it made what seemed like small adjustments, but which could have huge implications for bond purchases.
On July 8, the ECB changed its inflation target to 2% from “below but close to 2%” and accepted that the inflation rate could temporarily deviate above or below.
At first glance, this is not an earthquake. But when one realizes that the ECB’s own inflation forecast for a year as far back as 2023 is only 1.4% – even after its huge 1.85 Pandemic Bond Purchase Plan (PEPP) billions of euros expire next March-, then you can see how much work remains to be done to reach that 2%.
This week he plans to change his policy orientation to reflect that new strategy, and the head of the ECB, Christine Lagarde, insists that the ECB policy must be “especially strong and persistent” when interest rates are already below zero.
For ECB watchers, this underscores the fact that the ECB now regards bond buying as its main policy tool and will use it forcefully and continuously until it meets its objectives.
For a central bank that briefly raised interest rates in 2008 amid one of the largest bank failures in modern history – and repeated the mistake in 2011 as the euro sovereign debt crisis unfolded – the lesson of tightening premature has been learned the hard way.
So if the PEPP expires in March – assuming the pandemic actually ends by then – that “force” will have to be applied to its permanent Asset Purchase Program (APP), which was in place before the pandemic but continues to work together. to the PEPP with only 20,000 million euros per month.
Katharine Neiss, chief economist for Europe at asset manager PGIM Fixed Income, sees the issue as the credibility of the ECB in its fight against years of below-target inflation expectations.
“Your future effectiveness as an institution depends on you backing your words with the path of politics,” he said.
Neiss said he sees APP purchases scaled up to four times, up to € 80 billion a month after March.
That would be equivalent to an additional 720,000 million euros in 12 months to March 2023, a magnitude similar to the asset purchase announcement made at the height of the pandemic, in March 2020, and equivalent to a third of all the assets that the ECB has bought from 2014 to date.
And that count assumes that euro zone inflation is sustainable at 2% in March 2023. If it isn’t, another three months of that would surpass the trillion dollar mark – or a trillion euros more six months from now. of that.
Right now, the market does not see an inflation of 2% on that horizon. The Euro 5-year inflation swap remains stuck just above 1.5% – the leading market-based indicator of long-term inflation expectations – and has not risen above 2% since 2014.
But the forecasts also did not see this policy change coming. Just last month, the ECB’s own survey of analysts expected the PEPP to end in March and the APP to remain unchanged.
Clearly, reports of divisions within the Governing Council indicate that such strong guidance could meet resistance. And some hope the ECB will wait for the new September forecasts before getting more specific.
PIMCO’s portfolio manager Konstantin Veit believes that this week’s meeting will simply discuss the necessary adjustments to the ECB’s language on the targeting of interest rates and its framework. In September, he sees a more modest “rise” in the APP to € 60bn a month, as the PEPP ends with still “little” inflation progress.
Despite criticism of QE in other countries, there is no doubt that the ECB itself views asset purchases, along with negative interest rates and future guidance, as effective tools for raising inflation. A working paper published by the ECB last month concludes that euro zone inflation would have been 0.75 percentage points lower than the 1.3% recorded in 2019 had these tools not been adopted in the previous six years.
But for global markets in general, an additional purchase of bonds worth a trillion dollars, or even euros, by at least one of the “big 4” central banks over the next two years can be considered as another kind. of supply shock.
Given that the ECB is already buying far more bonds than creating governments’ underlying fiscal deficits, the shortage of ‘safe assets’ needed by banks, pension funds and insurance is likely to spill over considerably elsewhere. , which weighs on bond yields everywhere.
Even if the Fed starts cutting its QE, the ECB doesn’t look like it’s going anywhere for long.
(by Mike Dolan, Twitter: @reutersMikeD. Graphics by Saikat Chatterjee. Editing by Jane Merriman) . Translate serenitymarkets