The ECB’s Latest Words Are Nothing to Fear

For months, European Central Bank (ECB) President Christine Lagarde and other officials rebuffed speculation the bank would tighten monetary policy in response to elevated inflation rates. They pushed back on the possibility of interest rate hikes in 2022—though that stance seemed to shift somewhat last month. Then last Thursday, the ECB announced plans to accelerate the wind-down of its asset purchase program (quantitative easing, or QE), surprising many. The news spurred speculation about what the ECB sees going forward—and whether the bank will hike rates much sooner than most analysts anticipated. In our view, this is yet another reminder central bankers’ plans aren’t set in stone, so investors should refrain from treating their words and forecasts as roadmaps for future action.

The ECB’s QE efforts have topped headlines in recent years. The bank’s first program lasted from March 2015 – December 2018. Despite claims of QE’s purported stimulus power, eurozone GDP was already rebounding nicely from the 2011 – 2013 recession before the program’s implementation—and the slowing (i.e., tapering) and ending of bond purchases didn’t derail expansion. However, many (wrongly, in our view) see QE as critical economic support, so when eurozone GDP growth slowed in mid-2019, the ECB’s Governing Council voted in September to resume bond purchases at a clip of €20 billion a month beginning in November—to last as long as the bank deemed necessary. Several months later, in March 2020, the ECB launched the pandemic emergency purchase programme (PEPP) in response to COVID and its economic fallout, mirroring other central banks globally. This “emergency” QE combined with regular QE amounted to monthly bond purchases of around €120 billion.

As the eurozone economy recovered, Lagarde and Co. set the stage for slowing bond purchases—while vehemently denying it was a taper. At a September 2021 press conference, Lagarde declared, “The lady isn’t tapering,” after the ECB decided it would conduct emergency QE purchases at a “moderately lower pace” for the last three months of the year.^[i] At its December 2021 meeting, the ECB said emergency QE would end in March 2022 and recalibrated the monthly pace of regular QE: €40 billion in Q2 2022, €30 billion the following quarter and €20 billion starting in October, which would continue “for as long as necessary.”

That brings us to the present. With emergency QE still set to end in March, the ECB recalibrated its QE schedule again. It now plans to reduce purchases to €40 billion in April, €30 billion in May and €20 billion in June. Moreover, the ECB may decide to end asset purchases in Q3 depending on the economic data. Now, in our view, the ECB’s taper acceleration—and alluding to its conclusions—is a sign of things returning to normal. But many pundits bemoaned the “tightening” of monetary policy. Some claimed ECB hawks were now in control, which purportedly means the earlier removal of “accommodative” policy—with rate hikes expected by yearend—presumably hurting growth. Others posited the ECB sees inflation as a bigger risk, even more so than uncertainty tied to economic fallout from Ukraine-Russia.

While many observers seemed taken aback by the ECB’s decision, this isn’t unprecedented. The ECB’s monetary policy hasn’t traveled a smooth, uninterrupted path, and officials have taken actions that seemed to go against expectations they set. Throughout 2016 the ECB said monthly purchases of €80 billion would run until March 2017. That December, the Governing Council extended QE by another nine months, from March 2017 to December 2017, although it reduced the size of those monthly installments from €80 billion to €60 billion—a taper in all but name, despite ECB President Mario Draghi’s denials.^[ii] In 2017, pundits thought another taper was coming in July or September after the removal of language from the monetary policy statement. Those predictions were premature, as the ECB didn’t further reduce its purchases until January 2018. This flip-flopping is par for the course for other central banks, too. Last decade, the Fed and Bank of England (BoE) set expectations that unemployment rate levels would be the impetus for interest rate hikes. However, both banks adjusted their guidance and didn’t hike rates based on their initial criteria.

We reckon the handwringing over the ECB’s “hawkish” decision stems from a broader misperception: that economic growth relies on accommodative monetary policy. Take QE, which is more economic depressant than stimulant. Central banks’ bond buying pushes down long-term interest rates, and with short-term rates already near zero (or below zero in the case of many eurozone nations), the result is a flatter yield curve. That is a headwind for loan growth since banks borrow at short-term rates to fund long-term loans—and the difference between those two rates represents loan profitability. Ending QE removes that artificial downward pressure on long-term rates, in our view. Tapering is a step towards reducing that pressure, so we think tapers are more positive for growth than negative—despite the persistent misperceptions to the contrary.

Interest rate hikes aren’t inherently bad for the economy or stocks, either. For one, the issue has been widely discussed across developed nations—in the case of the Fed, chatter goes back to last year, and the BoE has already hiked—so it isn’t sneaking up on anyone. While most experts expect ECB rate hikes to lag the Fed and BoE, the chatter about ECB actions gives markets lots of information to digest. In the eurozone’s case, rate hikes would also probably be a positive, in theory, since it would end its negative interest rate policy—a marginal headwind, in our view. We think removing that “help” and allowing market forces to work unimpeded would go a lot further in stimulating eurozone growth than any of the ECB’s extraordinary efforts.