The ECB is at a dead end: the obstacles that prevent it from following in the wake of the Fed and the BoE

The great week of central banks is over and as expected monetary paths will continue to diverge. While the Bank of England has opened the ban with the first interest rate hike, the Federal Reserve, for now, has shown the intention of raising rates (up to three times) in 2022, while the European Central Bank (ECB) He is once again the laggard of the class after presenting a ‘vague’ roadmap to get out of ‘crisis mode’ and return to a less expansive position. The end of the plan is the return to the ‘box’ in which Mario Draghi left monetary policy at the end of October 2019: negative rates and net monthly purchases of 20,000 million under the APP program.

The ECB statement indicated this Thursday that after a progressive reduction in bond purchases, “as of October 2022, the Governing Council will maintain net asset purchases under the APP at a monthly rate of 20,000 million euros. for as long as it is necessary to reinforce the accommodative impact of its official interest rates “.

The central bank’s monetary policy will continue to be expansionary, less than it has been during the crisis, but the turn towards a real restrictive cycle seems still a long way off and uncertain. During the next few years, many things may happen, which, as has happened with the covid pandemic, prevent the ECB from starting what would be a real normalization, with rate hikes and a reduction in the balance sheet.

The ECB stays in the slow lane

Holger Schmieding, an economist at Berenberg, believes that “the ECB has stayed in the slow lane, considering the dramatic turn of the Fed and the BoE … Unlike the Fed, the ECB has not abandoned its insistence about what inflation is temporary because of bottlenecks and energy prices. ”

Carsten Brzeski, an analyst at ING, maintains that “he has opened a very cautious reduction process and with unclear details … it’s very hard to know where the ECB will go from here … this very open end to APP purchases and the fact that the ECB has always said it will stop asset purchases first before starting rate hikes it could be seen as a sign that there will be no interest rate hikes before the summer of 2023. “

Why doesn’t the ECB toughen up its policy?

The euro zone is a set of 19 countries with heterogeneous economies, different degrees of competitiveness, levels of debt, inflation, propensity to save / consume, etc. This greatly complicates the mission of a central bank that must ‘satisfy’ everyone and above all, even if it does not recognize it, prevent at all costs the fracture of the single currency.

The least competitive countries with higher levels of debt need low rates. The ECB’s announcement of a reduction in stimulus has already had a significant impact on peripheral debt. Risk premiums were extended this Thursday after the ECB announcement, so it is easy to imagine that it would happen before a real reduction of the balance sheet in which the central bank loosen ballast.

“Unlike the Fed, the ECB is not tackling the problem decisively because it is always looking at the highly indebted countries in the south of the monetary union … This shows once again that the ECB’s monetary policy decisions are always they take into account the financial needs of highly indebted countries, “says Jörg Krämer, chief economist at Commerzbank. A rise in interest rates can trigger a strong rise in the cost of debt for countries with more fragile economies, such as Spain, Italy or Greece, which also have very high debt-to-GDP levels.

In this context, the ECB and the Fed find themselves in unique political situations. “Faced with fiscal constraints in the euro zone, the central bank has acted as the main stimulus agent to support aggregate demand through monetary easing. However, current price pressures may require a tougher stance Despite the low growth trend and the risk of fragmentation of the potential market (such as problems with debt in some vulnerable countries), it would nevertheless find the negative of the countries “, they explain from the German insurer.

The Fed is an ‘inverted’ ECB

Meanwhile, these experts believe that the Fed has become something of an ‘inverted ECB’ in the face of current pressure from the US Treasury for the Fed to withdraw monetary support to control inflationary pressures (before they become chronic). “, they assure from Allianz.

However, the Fed could also be playing the game or feigning with its ‘dot-plot’: “The biggest challenge for the Fed is that it does not really have the margin to raise rates as much as they say without inverting the yield curve and slow down the economy more than they want, “Kathy Jones, chief fixed income strategist at Charles Schwab, told the Associated Press. CNBC. “What the market is telling you is that the Fed doesn’t have a lot of room to go beyond two or three hikes.”

Returning to Europe, another obstacle that the ECB faces in starting to raise rates or tighten monetary policy in the euro zone lies in the labor market. Although full employment is not part of the mandate of the ECB (as it is of the Fed or the Bank of England), there is no doubt that the strength of the labor market is one of the key factors (if not the most important) when determining structural inflation. The greater slack in the European labor market may prevent (or allow, depending on how you look at it) the ECB to keep its foot on the accelerator for longer. The unemployment rate, high part-time employment or stagnant wages continue to show a relatively weak labor market in the euro zone.

“We do not believe that the ECB is going to make a radical change. President Christine Lagarde has confirmed intentions to end the PEPP, as planned for the end of March 2022 … But compared to the Fed, the ECB can afford to be more patient. Although inflation has risen more than expected, we consider the acceleration to be “non-structural” in nature and we expect annual inflation to decline toward the target in the second half of 2022 as disruptions in the supply chain fade. supply and energy prices normalize. “

An OECD report released this week revealed that inflation in the euro zone is not yet a sustained or dangerous phenomenon, at least in theory. Organizational analysts use an indicator known as ‘truncated inflation’ (only weights the less volatile and less cyclical components of the basket) reveals that the pressure on prices is still biased towards certain products and is incomplete. So the ECB can still maintain the stimulus without worrying. However, both in the US and the UK, ‘truncated inflation’ is already showing warning signs, showing variation rates close to or above 4%.

“What is more important still, in Europe we see little evidence of second round effects, as inflation expectations remain largely anchored, “say Allianz economists. The problems for companies to find suitable workers in the US are increasingly serious, which is driving wages, especially the lowest , which in turn are the ones that present a greater propensity to consume.In a clear way, in the US the dreaded second-round effects could already be producing, while in the euro zone there are still no signs.

The strong rise in consumer prices in the US is becoming the biggest headache for the Biden Administration, which is seeing a drop in popularity. For this reason, while in the euro zone several governments call for a more expansive monetary policy, in the US almost the opposite happens, the Treasury asks the Fed to turn off the tap as soon as possible.

Few ‘real’ adjustments

With all of the above, “for the euro zone, we expect the cycle of rises to be even more superficial, which in turn suggests that there will be few adjustments in real terms. We believe that real interest rates will still be substantially below the natural interest rate in 2025, “they assure from Allianz. This means that monetary policy in the euro zone will continue to show an expansionary bias in the coming years and, therefore, , there will be no real restrictive cycle (in which nominal rates are above the natural interest rate plus inflation) throughout the period.

“Therefore, the next ECB tightening cycle will be left only in a gradual elimination of the current crisis mode, instead of being a clear departure from the accommodative monetary stance that was already prevalent before the covid-19 crisis,” say the economists of the German insurer.

Allianz experts believe that the first increase in the deposit rate in the Eurozone (now at -0.5%) will not occur until September 2023. This would be the first increase in a key interest rate to occur in the eurozone since the summer of 2011 and could usher in the first significant cycle of gains since late 2005.