MNI SOURCES: Fiscal Fears Prompt Talk Of Boost To ECB's PEPP

Some members of the European Central Bank's Governing Council are already discussing whether it could be forced to extend its Pandemic Emergency Purchasing Programme amid fears fiscal support for the eurozone will fall short, central bank sources told MNI.

While optimism is growing among some officials of a strong recovery in the second half of the year once vaccination programmes gain traction, others are less certain. And signs government spending may be constrained while the economy remains weak are already a concern. Controls on eurozone debt under its Stability and Growth Pact have been lifted via its general escape clause, not set to be deactivated until at least the end of 2021, but, as MNI has reported, fiscally conservative countries are pushing back against any permanent relaxation of the rules.

How the ECB should respond is "one of the most sensitive questions of all at the moment," one eurosystem official told MNI. Some national central bank officials are saying already that the PEPP may need to be extended "two to three years" beyond the current end point of March 2022, although the governors of other central banks insist on its temporary nature and hope that its existing EUR1.8 trillion envelope may not even be used in full.

"This is indeed the debate that is going on," an official from another central bank confirmed, adding that although it had not yet come down on either side of the discussion, "we think we should avoid doing more if we can and keep our powder dry."

MARCH MEETING KEY

The ECB's meeting next month will be key, the second official said, adding that supporters of extending the PEPP will face a hard time winning support. But opposition from the hawks varies in kind, from those who think "if we can avoid doing more we should", to others who say "over my dead body," barring a significant deterioration of the economic situation.

Recent improvements in inflation expectations were positive, officials said, though they should be regarded as responses to a rise in oil prices and the end of Germany's VAT cut that are likely to fade. Rate curves might be too sanguine regarding the prospect of interest rate hikes, one official noted.

"Either the market is pricing something [wrongly],"or we are not clear enough," the official said, before pointing to the ECB's symmetrical inflation target. "If they expect that we will start raising at [inflation of 1.5%}, it shows that this is not symmetric around two."

There are "powerful people who want" more PEPP, a source said. Those in favour are "more those focused on markets and what markets want," alongside central banks from countries most exposed to Covid lockdowns.

"There is a lot of debate," said another official, a self-described member of "the camp that sees strong mechanical rebound as soon as lockdown measures will allow it." "I don't think we will need that full [PEPP] programme," said another, predicting a "huge recovery in the second part of this year. But everything depends on what's the vaccination progress."

CRISIS TOOL

The question of whether and how to coordinate unwinding PEPP with the return of budgetary deficit rules has not formally been discussed within the Governing Council, the official added, but is likely to arise in upcoming seminars on the interaction of fiscal and monetary policy.

"PEPP is a crisis tool, and it's very closely tied not to economic weakness but to Covid stress and its implications," another official said, adding however that uncertainty about the future path of the Covid-19 epidemic means more major easing cannot be ruled out.

"The size of the package is not an absolute truth, just a kind of signpost, a guideline and guidance which way, approximately, is the volume we are going," the official said, pointing also to diminishing returns from bond buying.

An addition in the text accompanying the ECB's January's monetary policy decision of a reference to conducting net PEPP purchases "over the pandemic period" had added ambiguity to forward guidance, the official conceded.

But extending PEPP would not be the most likely response to an inappropriately tight eurozone fiscal stance, the official said, although he doubted that Stability and Growth Pact debt constraints would be enforced again before 2023.

"We might use other instruments most likely that would have some features of PEPP if it were necessary," the official said.

An ECB spokesperson declined to comment on the matters in this article.