2023-10-26 07:05:44
Published on Oct. 26, 2023 at 9:05 a.m. Updated on Oct. 26, 2023 at 9:27 a.m.
The European Central Bank is set to take a break this Thursday at its governing council meeting in Athens. The ECB has raised the interest rate during its ten previous meetings, a possible status quo on its interest rates would therefore be the first since July 2022.
The recent slowdown in inflation and easing of labor market tensions suggest that the recent round of monetary tightening is starting to feed through to the economy, but growth in the eurozone is also showing signs of recovery. shortness of breath. Moreover, the inflation rate is still more than twice the central bank’s target, although it fell to a nearly two-year low of 4.3% last month, a move that is expected continue in October. But that shouldn’t stop Christine Lagarde from making it clear that interest rates are likely to remain at, or above, their current levels for some time to come.
For observers, the virtual stagnation of the euro zone economy and the downward trajectory of inflation suggest that the risk of further monetary tightening is limited. The conjunction of PMI indicators signaling a continued contraction in activity and a tightening of credit standards on the part of euro zone banks also reinforce the scenario of a more flexible decision on the part of the ECB, which THURSDAY. The central bank’s survey on borrowing conditions in the third quarter shows that net demand for credit continued to decline sharply, especially as that from large companies fell by 36%, almost as much as during the low point reached during the financial crisis, with a collapse of 37% in the last quarter of 2008.
Inflation remains excessively high
This decline in demand provides the ECB with further evidence that monetary policy is continuing its path through the economy, reflecting a less pressing need for the central bank to tighten its tone at the moment. At the same time, the deterioration in activity, which is now spreading to the services sector after first affecting the manufacturing sector, is prompting central bank officials to be cautious about how long it will take to navigate “the last mile” of their journey to bring inflation back to their 2% target.
Christine Lagarde said this month that inflation remains “ excessively high “. Additionally, the war between Israel and Hamas has fueled fears of an extension of the conflict in the Middle East and boosted oil prices, which could keep prices stubbornly high. Enough to represent an additional risk for inflation. Downside risks to growth have also increased at the same time, “ which further complicates the picture for the BCE,” explains Dirk Schumacher, former central bank economist, now at Natixis.
Reducing the balance sheet via the PEPP
Another theme that could be discussed today is the possibility of monetary tightening through a reduction in the central bank’s balance sheet. Thus, the ECB could open the debate on stopping reinvestments of the portfolio of 1,700 billion euros of bonds constituted during the health crisis within the framework of the PEPP (Emergency Purchase Program for the Pandemic) before the end of 2024 as initially planned. In the absence of a decision on this point, the ECB would run the risk of destabilizing the markets. “ We would not be surprised if the ECB brought forward the date for the end of reinvestments in the PEPP by several quarters », Indicates Reinhard Cluse, chief European economist at UBS. “ What matters is that they [la BCE] must make an announcement before starting to lower interest rates. Otherwise, communication will be very difficult “, he argues.
The recent sell-off in the bond market, which brought the yield on government bonds to their highest level in ten years, has, however, made some board members nervous about a reduction in the balance sheet. For them, the ECB needs a certain flexibility to direct the proceeds of maturing loans towards the debt of certain countries which could be impacted by a strong divergence, or fragmentation, in their financing costs compared to other countries. others.
The risk of fragmentation monitored
The cost of Italian borrowing has risen more than Germany’s due to concerns over Rome’s rising budget deficit, pushing the spread between the two countries’ 10-year bonds to more than 200 basis points for the first time in months.
« There is a strong argument in favor of stopping PEPP reinvestments before the end of next year “, it would be ” consistent with our interest rate policy said Madis Mudler, member of the board of governors, last month. The ECB has not updated the general orientation of the PEPP since December 2021, well before the start of the monetary tightening cycle. At the time, she predicted that future developments would be “ managed so as not to interfere with the appropriate monetary stance ».
This program was used from the beginning to direct the proceeds of reinvestments towards Italy, Spain and Portugal, rather than towards Germany and France. While markets have since stabilized, the recent surge in Italian bond yields shows how quickly investor confidence can deteriorate. Even some of the council’s most hawkish members, like Slovenia’s Bostjan Vasle, are reluctant to give up a tool that could restore calm if necessary.
Towards a reduction in bank remuneration?
This is particularly the case at a time when delays in the overhaul of the European Union’s budgetary rules could lead to an extension of those in force, which would potentially force governments to consolidate these budgetary rules, at the risk of penalties which could destabilize investors. But with the threat of Covid having largely passed, not touching the PEPP becomes difficult to justify. Recent comments from ECB officials, however, show that the Governing Council is far from a consensus on the matter.
Another possibility is that several council members are calling for a reduction in the interest rates that the central bank pays to commercial banks. To do this, the ECB would increase the minimum amount of reserves that establishments entrust to it and from which they receive nothing. A solution recently rejected by the vice-president of the ECB, Luis de Guindos, on the grounds that it would have the effect of reducing the large losses accumulated by national central banks rather than serving the fight against inflation.
The debate should therefore not be resolved before December, the date on which the ECB will present its new economic projections, and perhaps even before a more complete review concerning its operational framework, planned for spring 2024.
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