ECB debate reflects growing inflation fears, Sept accounts show

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With the economy now on a solid footing and inflation well above the ECB’s target, policymakers are preparing for a key debate in December on winding down support and on whether the longer-term inflation outlook still warrants ramping up other stimulus measures to pick up the slack.

In its first albeit token move to end pandemic-related stimulus, the ECB decided last month to “moderately” cut bond purchases. But some policymakers made the case for a bigger reduction, arguing that the central bank’s response was out of sync with the recovery.

“It was argued that a symmetric application of the (Pandemic Emergency Purchase Programme) framework would call for a more substantial reduction in the pace of purchases,” the ECB said. “From this perspective, a pace of purchases similar to the level prevailing at the beginning of the year would be appropriate.”

Some policy hawks went even further, arguing that markets had already prepared for the end of emergency purchases without a significant impact on financing conditions, so investors were well-prepared.

“The argument was made that markets were already expecting an end to net asset purchases under the PEPP by March 2022,” the accounts showed. “The point was made that, even without the PEPP, the overall monetary policy stance remained highly accommodative.”

In the end, the ECB opted for a more cautious move, fearing that a bigger stimulus cut could be seen as a step towards exiting its easy monetary policy, a premature move given weak inflation prospects over the medium term.

INFLATION

While ECB chief Christine Lagarde played down inflation fears after the policy meeting, the accounts showed greater concerns about price pressures, even if policymakers still maintained their baseline view that price pressures would ease next year.

Inflation jumped to a 13-year-high of 3.4% last month and could still hit 4% this year, even as the ECB sees price growth slipping back below its target over the next several years.

“Risks to the inflation outlook… were widely regarded as being tilted to the upside,” the accounts showed, with policymakers arguing that the ECB must keep an eye on a possible inflation “regime shift”.

While wages were not indicating that high inflation could become entrenched, some warned that the length and magnitude of the spike along with supply bottlenecks and excess savings could lead to higher second-round inflation.

Policymakers also contemplated whether their projection models were working properly given the big inflation overshoots this year.

“This raised doubts about how well the models relied on in the projections were able to capture what was currently happening in the economy, the structural changes implied by the pandemic and the impact of the ECB’s new monetary policy strategy,” the ECB said.