MNI SOURCES: Inflation Ups Odds ECB Will Slow Q3 Bond Buys

A subtle shift by European Central Bank policymakers towards a less dovish line on inflation raises the chances of a further reduction in the pace of bond purchases from as early as mid-year, Eurosystem sources said, stressing that the overall tone of policy remains highly accommodative and rate rises are very unlikely before next year.

With inflation reaching 5.1% in January, officials remain sceptical that the eurozone will see a self-reinforcing price cycle fed by higher wages, and sources told MNI that even higher March forecasts were unlikely to prompt any adjustment to policy before June.

“For sure the hawks will be making more noise,” one Eurosystem official said. But, he added “I'm not sure it's correct to say there has been a hawkish shift as much as to say we are certainly more watchful, particularly on prices.”

High inflation, particularly if confirmed in March’s ECB forecasts, could prompt a “fine-tuning” of third-quarter bond-buying plans in June, the official said, though he stressed that this was by no means certain. In December, the ECB said it would buy EUR40 billion a month under its Asset Purchase Programme from the second quarter, reducing this to EUR30 billion in the third quarter and to EUR20 billion for as long as necessary from October.

“Personally, I see net new bond buying ending at the end of the year. As for the first hike, my personal guess is the middle of 2023,” the official said, “But the tightening cycle from there will be very gradual and only a reflection of continuing to remove emergency stimulus.”

POLICY CALIBRATION

Another official agreed policy could be calibrated for the third quarter if necessary.

“If we see that inflation gets more entrenched, and the labour markets start to price in more information and higher wage increases are seen, then I personally would certainly see it as a decent question to ask: ‘do we really need to be providing this much support until October?’”

For the moment, below-target inflation into 2023 and 2024 remains the outlook, the official noted.

“But I think it is increasingly likely that we do get to 2%, so this discussion of being able to attain our target becomes more credible,” he said. “That's a very strong signal in my view for fiscal policy that rates will go up. We will try not to rock the boat so that this does not kill the recovery, but most likely [they] will go up.”

A majority of Governing Council members now see upside risks to inflation in the coming year, though short-term spikes will be easy to look through, said another official, who also suggested bond purchases could be calibrated fairly soon, in June or even in March.

Currently, the ECB expects net bond purchases to continue until shortly before it raises interest rates. Rates will remain at current or lower levels until it sees inflation on target well ahead of the end of its three-year projection horizon and underlying inflation is consistent with 2% over the medium term.

CHANGING DEFINITION OF DOVE

Any change in this tightening sequencing is unlikely for now, another Eurosystem source said.

“There are reasons why we chose this path, and these reasons remain valid. I am confident with the general view that inflation is temporary and that it can drop very quickly, even if maybe not as quickly as we initially predicted.”

Changes to forward guidance are not imminent, the official added.

“I think we are very far from there yet. And I would say that we need some months to see it,” the official said. “Talking about this now for me is a way of trying to shift the position in order to gain ground when the real discussion starts.”

While ECB policy remains accommodative, Governing Council members are beginning to consider their position, one of the officials said.

“I see that we are close to the turning point when we will be able to exit the support. First we will have those discussions: is that purchases first, as currently we have, rates later, which I think at the current moment is the reasonable choice?” the official said. “I would not say that that means there is an exodus from the doves to the hawks, but when the situation changes the definition of hawk and dove also changes.”

An ECB spokesperson declined to comment to MNI.