ECB Still Excessively Cautious?

Posted December 1, 2016 by rvillareal

Summary Highlights

• The result of the ECB meeting next Thursday seems to be a ‘done-deal’. The question it seems is whether the well-advertised extension to the ECB bond purchase program will involve purchases at the current rate of € 80 bln per month and and/or whether some tapering will be introduced for after the likely added six month of purchases draws to an end.
• Markets may be less interested in the details of the looming meeting because the ECB may now defer any change to the terms on which the current bond purchase scheme is based, as circumstances have changed very much in the last few weeks, allowing the ECB more time to decide if and how parameter changes may be made.
• Amidst all the speculation about what the ECB may do and when, few it seems are asking whether the central bank needs to or should do more. The ECB is categorical that it will continue with some kind of bond purchase program until it sees a sustained rise in inflation. This is stretched logic!
• Indeed, a view is emerging within the Council that the traditional relationship between the real economy and inflation has broken down. If so, this is a clear indictment of the inflation targeting regime the ECB allegedly says it is pursuing.
• There is no logic in how or why further bond purchases should boost inflation, save for (possibly) helping to provide downward pressure on the currency. Even then, the ECB has not made it clear what is the more important; the change in stock of assets (ie the flow) or the actual stock!
• The question is why the ECB wishes to continue with a policy tool, ie bond purchases, which have failed so clearly in raising inflation. Notably, the ECB is not the only high-profile organization that has repeatedly over-estimated inflation. But this systemic inflation bias is all the more notable given the equally-systemic under-prediction of the real economy backdrop.
• There are two key themes that the ECB should be more willing to acknowledge but may be unwilling to do so at the current juncture. Firstly, price pressures are emerging, both from the demand and the supply side. Secondly, the current backdrop clearly sees robust consumer and business survey data.
• Most likely the ECB, very clearly wary that political events (eg the Italian referendum could cause a return of financial market turmoil in some Eurozone countries, will argue that this mean it should extend the bond purchase program but at a smaller scale than the current plan (eg € 60 bln a month) with the possibility of it then being tapered at a later stage!