A special European Central Bank meeting next week will discuss running unconventional monetary policies despite higher-than-2% inflation in key countries – exposing persistent fault lines between debtor and creditor members of the monetary union.
The ‘conclave’, the latest in a series of top-level behind-the-scenes sessions designed to conclude the ECB’s long-running strategy review, is intended to provide clarity on asset purchases and other sensitive monetary issues in the euro area. An announcement may be made after the Frankfurt meeting – depending on whether agreement is reached on complicated outstanding points.
A group including the heads of the German, Dutch, Belgian and Austrian central banks has been preparing tactics for a clear decision on ending, on schedule at the end of March 2022, the €1.85tn pandemic emergency purchase programme.
By contrast, a heavyweight faction of central banks from southern states, mirroring views of Philip Lane, board member for economics, wishes to maintain flexibility on PEPP, lowering asset purchases in the autumn but possibly extending it beyond March next year.
The meeting, anticipated to start with a governing council dinner on Tuesday 6 July and extend through Wednesday and possibly Thursday, can be expected to put the finishing touches to the ECB’s long-mooted ‘symmetrical’ definition of price stability aimed at 2% inflation.
By adjusting the current wording (in place since 2003) of ‘close to but below 2%’, the ECB is recognising that it may overshoot inflation in coming years after persistently undershooting the reference level for most of the past decade. A key issue dividing the hawkish and dovish groups is whether the ECB should agree merely to ‘tolerate’ compensatory overshooting in 2022-23 – or should adopt this objective as a direct expression of policy.
The debate, which Christine Lagarde, ECB president, has been anxious to prevent from spilling into public controversy, runs parallel to the discussion at the US Federal Reserve on a possible ‘make-up‘ of past low inflation by allowing higher price rises in the future. Jens Weidmann, the Bundesbank president, backed by strong sections of conservative German opinion, has set down firm reasons opposing a ‘make-up strategy’.
Next week’s gathering is sensitive for three interconnected reasons. First, reflecting the special nature of the strategy review and Lagarde’s efforts to overcome some of the bitterness that characterised ECB debates under Mario Draghi, her predecessor, the ‘hawks’ on the governing council are unlikely to be outvoted in this round of discussions. This gives the harder-line faction some clout – but also makes them wary about squandering goodwill among other ECB members more open to semi-permanent use of unconventional policies. Those favouring less accommodative ECB policies know that they have more power to influence the strategy review than they would for a normal monetary policy decision – but they are aware that vetoes have to be used wisely. Some of these tactics were displayed in the last monetary policy meeting of the government council on 10 June, when ‘hawks’ acquiesced without strong objections to the Lagarde-Lane policy of continuing PEPP at relatively elevated buying levels during the summer.
Second, German inflation has been picking up along with the faster-than-expected German recovery. The Bundesbank has been progressively raising its estimate of German inflation and growth, both now seen as close to 4% by the end of the year. Core and headline inflation in the euro area, on the other hand, are significantly lower, predicted respectively at 1.1% and 1.9% in 2021, 1.2% and 1.5% in 2022 and 1.4% each in 2023. Weidmann at the Bundesbank – although ratcheting up language on ending PEPP with the conclusion of the Covid-19 emergency – has said he expects German inflation to abate next year, but to remain above euro area levels. Many other governors want further large ECB asset purchases to increase the overall euro area inflation rate. This raises the difficult issue of whether the ECB should be considering the needs of Germany, its largest economy and biggest creditor, or whether it should counter German thinking and focus on the requirements of the entire euro area.
Third, the issue looks likely to become hotly debated ahead of the 26 September German parliamentary election. The Christian Democratic Union/Christian Social Union grouping of retiring Chancellor Angela Merkel, widely expected to form the biggest faction in the next Bundestag, has set a programme of ‘solid finances’ for Germany and Europe. It has also promised widespread ‘green economy’ spending and pledged no tax increases – raising doubts on how it will finance programmes if interest rates rise. People close to Armin Laschet, North Rhine Westphalia prime minister, CDU chairman and anticipated next German chancellor, say he is determined to ensure that Europe does not become over-reliant on cheap ECB money. Francophile Laschet, if he runs the next German government, is, however, likely to face cajoling from French President Emmanuel Macron not to allow the ECB to cancel PEPP on 31 March next year – just 10 days before the first round of Macron’s presidential election fight against right-wing rival Marine Le Pen.
All these points will weigh on next week’s gathering. Drama will be present in plenty – but, as one insider says, it will be the theatre of a fencing match rather than the gladiators’ arena.
David Marsh is Chairman of OMFIF.