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Rising eurozone inflation is stiffening oppositon to a large extension of ECB stimulus beyond next March.
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Expectations for the size of monetary stimulus following the conclusion of the European Central Bank's Pandemic Emergency Purchase Programme in March are ratcheting lower, with Governing Council debate seen focussing on adding flexibility to an older bond-buying scheme and the possible creation of a "sleeper" facility only to be used during market stress, eurosystem sources told MNI.
As fears rise that higher inflation could prove more than transitory, hawkish rate setters, who for the moment seem to have seen off suggestions of an extension of the PEPP, are resisting any indefinite expansion of the size of the Asset Purchase Programme.
While some hawks would accept an increase in monthly APP activity if capped within a fixed envelope, another proposal aimed at finding consensus would be for APP bond-buying, currently running at EUR20 billion a month, to be fixed in annual terms, permitting the pace of purchases to be increased when necessary so long as the year's total falls within the agreed limit, one source said.
"APP should be more flexible – but over time," the official said. "When markets are quiet, we spend a little less."
Market expectations are for a bulked-up APP to avoid a "cliff-edge" effect from the end of PEPP, but the official said this was less important than making APP more able to respond to circumstances.
"It's not a huge priority to increase the APP from EUR20 billion to EUR30 billion, and I don't think the hawks will have it. What good will this do, especially when we have inflation doing what it is doing?"
HAWKS IN ASCENDENT
While officials earlier in the year mooted proposals for loosening capital key limits on purchases of government bonds, these have lost ground. Boosting the ceiling on supranational bonds - such as those issued under NextGeneration EU - from 50% to 75% of those issued, would be less controversial, several sources said.
One source agreed that the tide was turning against calls for bigger stimulus, but noted that the situation was still fluid.
"In spring and summer it seemed like the doves were always winning and now you are telling me about a big hawkish momentum. This hawkish moment, as you say, could fade away," the source said, adding that making the APP more flexible without adding to its size may not convince markets.
For the moment, though, the hawks are in the ascendent.
The National Bank of Belgium's Pierre Wunsch told MNI earlier in October that any APP add-on should be time-limited. While putting such limits such as an envelope on the APP might have been difficult under the ECB's older guidance, because continued purchases signalled an intention not to raise rates, some hawks may argue that the programme can now be adjusted without damaging the credibility of the 2% medium-term inflation target.
Another possible move doing the rounds in the lead-up to a key December meeting is the creation of an additional QE tool, only activated at times of market stress – a proposal which MNI heard from several officials. One source said the part of the EUR1.85 trillion PEPP envelope likely to remain unused could be assigned to a sleeper facility.
"My feeling is that we will be asking for flexibility and for this virtual instrument," the first source said, adding that reassurance could be given to hawks that the sleeper instrument may not have to be used at all. "Its mere existence means that we might not actually have to use it."
A sleeper facility could be employed in case bond spreads widen dangerously, and would be particularly useful for Greece, whose sub-investment grade bonds will cease to be eligible for ECB purchases once PEPP ends. Some hawks though, are likely argue that such a tool would come close to making the ECB a lender of last resort, and would be unnecessary given the existence of Outright Monetary Transactions.
Executive Board members are also said to be reluctant to create an instrument that could be interpreted as targeting country-level problems.
Proponents of a 'sleeper PEPP' know they face an uphill battle, said another source.
"I don't see much support for creating something new. On the contrary the camp seems to grow, which is in favour of letting things diminish or even reduce amounts ahead of schedule," the official said, though he stressed that it was difficult to predict the outcome of the December meeting. "Opinions seem to move around without any clear direction at the moment."
While this week's Governing Council is unlikely to produce policy changes, as seasonal factors and lower issuance in November and December naturally slow the pace of PEPP purchases into the New Year, members will be aware that rising inflation is feeding through into public debate. Chief economist Philip Lane has pushed back against market expectations of a rate hike late in 2022, and this message is likely to be repeated, in line with the ECB's revised guidance.
Officials will want to see December's macroeconomic projections before deciding on post-PEPP courses of action.
"Ideas are certainly building, but there are still no clear leading thought lines yet, although I think ending the 'emergency phase' of the crisis does seem likely," another Eurosystem official told MNI, noting that crunch talks will take place in two symposia after this Thursday's meeting.
December's Targeted Longer-Term Refinancing Operations auction could be the last on ultra-easy pandemic terms, the source added, though a new, 'green' TLTRO aimed at low-carbon lending may be on the cards.
An ECB spokesperson declined to comment to MNI for this story.