ECB – Ending Policy Stimulus and Managing Transition

The European Central Bank (ECB) governing council has announced that net purchases under the Pandemic Emergency Purchasing Program (PEPP) will be discontinued, by the end of March 2022. This will end the pandemic induced ECB stimulus worth 1.85 trillion or $2.1 trillion. To mitigate this transition, ECB will also double its Asset Purchase Program (APP).  The pandemic has resulted in inducing new set of restrictions in certain countries. Energy prices have been continually increasing and impacting the commodity prices as well as leading to inflation. Higher energy prices are slowing down the progress of the economy and if the price hike continued, it will continue to impact the growth in the near term. Manufacturing companies are facing issues globally due to continuation of supply-chain disruption. However, situation may improve during 2022 when the supply chain issues may get resolved and job market get further strengthened. The demand may improve backed by the improvement in purchasing power.           

The Governing Council believes that a gradual reduction in the pace of asset purchases can be made in the coming quarters as the economy is recovering and there has been progress in meeting the medium-term inflation target. However, in the medium term, accommodative monetary policy will be required till the time inflation stabilise at 2% target. During 2022, though the inflation will remain above 2% but factors inflating price hike are set to become weaker. Since the global recovery is uncertain, supply chain issues are not yet resolved and threats from new variant is still looming, ECB has to maintain flexibility as well as optionality in framing the monetary policy.

On a long-term basis ECB expect economy to grow strongly. The euro area economic growth may be around 4.2% in 2022, followed by 2.9% growth in 2023 and 1.6% growth in 2024. Similarly, inflation is expected to be around 3.2% in 2022 which may moderate to 1.8% in 2023 and continue at that level till 2024.  According to Christine Lagarde, President of the ECB, uncertainty related to energy prices, Omicron, mismatch between strong demand and supply shortage are some of the factors leading to revision in the inflation target and for gradually reducing the amount of asset purchases.  

Ms Lagarde has emphasised on the element of flexibility in the design and conduct of ECB asset purchase policy and how flexible policies have helped in countering the impaired transmission of the monetary policy, for the purpose of achieving the ECB’s objective. PEPP was designed with the flexibility attribute for transitioning the economy out of pandemic and the current policy measures have support of broad majority.

Though ECB will discontinue net asset purchases under the PEPP program by the end of the first quarter in 2022, it will extend the period of reinvestment of PEPP till the end of 2024 and roll-off of PEPP portfolio will not interfere with monetary policy stance. ECB will avoid the ‘Brutal Transition’ by temporarily doubling up Asset Purchase Program (APP) from 20 billion to 40 billion.   According to ECB the risks to the economic outlook are broadly balanced at this stage. The eventuality of key factors e.g. Consumer spends more, energy prices stabilises, supply chain bottleneck resolves, Job markets improves, inflation etc have been factored to arrive at the policy.

Bureau Galactik Views

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