Column-shaped turtle against hare, ECB could “normalize” before Fed: Mike Dolan | The powerful 790 KFGO


By Mike Dolan

LONDON (Reuters) – If the world’s major central banks are convinced the economic emergency is over and politics should start to revert to pre-pandemic parameters, the ECB is likely to beat the Fed.

Faced with the highest inflation rates in decades, caused mainly by the distortions and bottlenecks associated with the rapid reopening of economies after the serial COVID-19 lockdowns, central banks fear these rates will decline slower than initially thought.

The Omicron wave towards the end of the year once again blurred the economic picture and could prolong supply chain and labor market distortions that keep inflation rates higher for longer. , while increasing the risk that they become part of the expectations of households, workers and businesses.

If in doubt, the message seems to be: stop adding stimuli, go back to square one, and assess the lay of the land.

U.S. Federal Reserve officials entered 2022 with all the guns on it. Most now insist that they will not only stop buying new bonds by March, but that the first of at least three interest rate hikes this year will come at that time and the unwinding The Fed’s inflated balance sheet will begin shortly thereafter.

Fed Chairman Jerome Powell spoke on Tuesday of “normalizing” politics while being “humble and nimble.”

Although the situation of the European Central Bank is different, it faces a similar inflation and communication problem, and the message from its senior officials is both a message of caution in the face of inflation risks and a reaffirmation of its central mandate of price stability.

ECB chief economist Philip Lane said this week he still expects inflation to return below the 2% target next year and into 2024, while its president Christine Lagarde spoke Tuesday of an “unwavering” commitment to stable prices and the new boss of the Bundesbank Joachim Nagel said he sees inflation “danger” remains high.

For many in the markets, faced with a more modest economic rebound, higher unemployment levels, lingering credit problems and an aging demographics that threatened deflation for a decade, the ECB will remain deeply accommodating for much longer. than the Fed.

A nearly 10% collapse in the euro / dollar exchange rate in the second half of last year partly illustrates this.

ECB policy rates and long-term benchmark sovereign bond yields were negative before the pandemic and remain so. And the size of its accumulated balance sheet is both larger than that of the Fed in nominal terms and is, at over 65%, nearly double the share of gross domestic product as Washington’s.

But as UniCredit economist Marco Valli points out, much of the ECB’s position was in place before the pandemic.

“When the various starting points of monetary policy are taken into account, the ECB’s position seems less accommodating than is generally thought,” he wrote.


Valli believes that, based on his Dec. 16 decisions – which aims to end the emergency pandemic bond purchase stimulus by March, to end the new special loan facilities by June and bring long-standing asset purchases back to pre-COVID levels by Q4, the ECB would be back to pre-pandemic settings by October, a year ahead of the Fed on existing plans.

Of course, the Fed cut its key interest rate by more than 150 basis points and rearranged its net bond purchases from scratch when COVID hit. In contrast, the ECB relied mainly on the PEPP bond purchase program as the main support for long-term interest rates. Its repo rate was already at 0% since 2016 and its deposit rate had already been lowered to the current -0.5% in 2019.

But Valli says it’s still worth noting that the ECB will be back to pre-COVID levels well before the Fed despite less labor market distortions fueling wages, less exchange rate weakness on prices. imports and less worry about stock valuations.

Either the Fed has been too slow to normalize – and judging by its frenzied speeches this year, some Fed officials seem to think so – or the ECB is being too cautious.

“The former seems more likely,” Valli concluded.

The market’s valuation of a slight 10bp hike in the ECB’s deposit rates by year-end still seems excessive to most economists.

Deutsche Bank’s “House View” released on Tuesday indicates that this “take-off” is unlikely until 2023, but it sees net asset purchases fall by around 70% this year.

On the flip side, even if the Fed were to hike rates four times this year, as market prices now suggest, it would still leave them well below pre-pandemic levels.

A rapid decline in the Fed’s balance sheet this year could even boost relative positions somewhat, as the ECB’s cut seems much more distant. But the Fed’s Powell said on Tuesday that no decision on the matter had yet been made.

So while the ECB may seem more of a hare-like turtle to the Fed, it may also find that it is winning the race. Whether this is a good result for the euro area economy is less clear.

The author is editor-in-chief for finance and markets at Reuters News. All opinions expressed here are his.

(by Mike Dolan, Twitter: @reutersMikeD; edited by Alexander Smith)


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