MNI INTERVIEW: ECB's March PEPP Move Hampers Decision-Making

The European Central Bank should keep its definition of "favourable financing conditions" vague, in order to avoid setting targets for investors, but the decision to seek consensus among ECB policy makers before addressing a global bond market selloff in March may empower more hawkish officials, a member of Ireland's Fiscal Advisory Council told MNI.

The ECB has avoided specifying what it means by the favourable financing conditions it seeks to preserve, even as yields surged last month. This avoids the danger that markets will move abruptly on particular data points, Oxford University professor Michael McMahon, also a former eurozone economist at the Bank of England, said in an interview.

"The ECB could tell you tomorrow exactly which spreadsheets, what data and what weights [it uses to assess the favourability of financial conditions]," McMahon said. "They want to be precise, in that they are being guided by the state of markets, but exact precision would actually be counterproductive."

Similarly, McMahon said Federal Reserve Chair Jay Powell has been right to avoid giving clearer guidance on when the Fed might start to roll back easy monetary policy, given lingering uncertainties.

McMahon though was critical of the recent ECB Executive Board decision to consult its Governing Council before it issued a statement committing itself to increasing the rate of its purchases under its Pandemic Emergency Purchase Programme as investors probed the limits of "favourable financing conditions" in March. The Executive Board could normally have ordered an increase in the rate of purchases without further ado, but ECB officials have told MNI that President Christine Lagarde decided to consult the Council as part of her consensual approach to decision-making.

COMMUNICATIONS CHALLENGES

Going to the Council set an unfortunate precedent, and may allow more hawkish members to slow decision making in the future if the recovery takes longer than hoped, McMahon said.

"We can all envisage a situation where these things drag out longer, or countries are weaker for longer," he continued. "You would hope that they don't pull the rug out too soon, or they're not forced to. But if they are, I can imagine it would be a difficult communication. Again, the kind of inequality or the heterogeneity of the effects that this could have across countries could be massive."

The multi-speed eurozone recovery could already be set to place ECB communication under strain at a time when political differences within the currency union are becoming increasingly pronounced. Pointing to the rise in German inflation as a portent of tensions to come, McMahon noted that the ECB will have to set monetary policy for the eurozone as a whole, even though it may be inappropriate for the needs of individual member state economies.

While the ECB dealt with an opposite situation at the time of its creation, when the German economy was weak, the politics are now more fraught as the bloc's disparate economies emerge from the Covid pandemic at different speeds.

"Suddenly trying to get German inflation back under control, but in doing so hammering Portugal. That politics of it is going to be part of the communication challenge, but we're not there yet," McMahon said.

Another challenge for the ECB will be raising rates after its easy policy has allowed governments to fund massive fiscal responses to the current crisis.

"The issue I'm increasingly worried about is that by fiscal becoming so relevant [...] the decisions made on the monetary policy side have much greater implications for fiscal authorities.