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It is time for the ECB to talk about tapering

Coronavirus economic impact updates

Central bankers, just like employers, governments and health services, are having to grapple with the question of exactly what “normal” will look like after the pandemic. For the European Central Bank, which on Thursday announces its latest policy decisions, the answer is crucial to decide how fast and how far to scale down the additional asset purchases it launched at the start of the pandemic. Like its peers at the Federal Reserve and the Bank of England, it is now time for the central bank to begin setting out its eventual exit strategy. 

In its own words, the ECB’s pandemic emergency purchase programme, a bond-buying scheme, was designed to continue until the governing council judged that the “crisis phase” of the pandemic was over. With a high rate of vaccination in the EU, reducing both the spread and the deadliness of the coronavirus, it is hard to argue that the crisis phase is not, at the very least, fading. A decadal high in inflation and strong growth figures both add to the argument that the extraordinary circumstances that justified bolstering the central bank’s existing stimulus efforts are now on their way out. 

Unlike the Fed, the ECB’s PEPP programme targeted a total amount of purchases — expanded to €1.85tn last December — rather than a monthly rate of bond buying. That means there was always an end date baked in. With around €1.3tn bought already by the end of July and a current rate of purchases of around €60bn to €70bn, the scheme would come to an end anyway by next March, its two-year anniversary. 

With the virus unlikely to disappear altogether, however, and the economy still recovering from shutdowns, some additional support will probably still be needed to get back to where it was before the crisis. The Fed’s dilemma over “tapering” its own asset purchases has been complicated by the spread of the more infectious Delta variant in the US, slowing the pace of recovery. A higher rate of vaccination in Europe means there is less of a problem but some restrictions and voluntary social distancing will remain. 

The outlook is still unclear and the recovery not yet assured. High growth and inflation figures partly represent the effect of last year’s shutdown on the data rather than the underlying strength of demand. Monthly inflation data suggest the pace of price growth is already slowing. The central bank, too, set out a more dovish approach to its inflation targeting earlier this year, which would sit oddly with a return to the pre-coronavirus status quo on monetary policy.

Nevertheless, the behaviour of markets suggest the central bank can signal it intends to scale back its purchases without causing a tightening of financial conditions. Government bond spreads — the difference in the interest that investors charge, say, Germany and Italy — remain narrow. Similarly the real yield on euro-denominated junk bonds turned negative for the first time this week, falling below the headline rate of inflation, while the Europe-wide Stoxx 600 equity index reached a record high in recent weeks. A slight pullback of the central bank’s asset purchases would therefore match the improvement in risk appetite among investors.

At its Thursday meeting the central bank needs to explain clearly and credibly how it plans to wind down the PEPP and whether it will expand pre-existing monetary stimulus to compensate for the end of the scheme. It would be premature to actually start tapering, but setting out how it plans to do so will make the eventual shift much easier.

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