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ECB set to dial back stimulus one more notch -Breaking

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© Reuters. FILE PHOTO : Frankfurt, Germany, February 23, 2020. REUTERS/Ralph Orlowski/File photo

Francesco Canepa and Balazs Koranyi

FRANKFURT (Reuters – It seems that the European Central Bank will cut back on its stimulus on Thursday. While pledging support for the financial system in next year’s fiscal year, it is still sticking to its long-held belief that high levels of inflation will recede on their own.

The euro area’s economy is now at its pre-pandemic level. Pressure mounts on the bank that it follows its international peers and shut down the money taps. However, policymakers fear that too fast a reaction could ruin years of hard work in restoring once-anaemic inflation.

Unusually uncertain prospects could make it difficult for rate-setters and other decision makers to postpone many big decisions. This would leave policy extremely flexible, with very few commitments.

It is expected that there will be some clarity regarding the ECB’s 2022 policy. Policymakers can fill in details as they gain more confidence in the fact that inflation, currently running at more then twice the bank’s 2% target level in 2022.

One thing is certain: Bond purchases under the Pandemic Emergency Purchase Programme of 1.85 trillion Euros will decline in the next quarter and be retired at March’s end. The long-standing Asset Purchase Programme will however be elevated to compensate for the loss of stimulus.

Reuters survey of analysts revealed that total purchases may still be around 40 billion Euros per month. That’s less than half what is currently being bought.

However, the effective reduction in stimulus may be smaller as new government debt issuance is likely to decline. Therefore the ECB will continue its efforts to collect most of the new loans.

It is likely that the ECB will signal its intention to continue purchasing bonds throughout 2018, in order to control yields and eliminate any potential rate increases in 2022.

At 1245 GMT the policy decision will be made. Following that, Christine Lagarde, President of the ECB, will hold a news conference at 1330 GMT.

MOVING PARTS

A plethora other choices are available.

The problem with this is that, although the ECB projects inflation returning to target by 2023, but holding steady in 2024, many policymakers are skeptical of that narrative.

It makes no sense to not provide parameters for the asset acquisition program. They might provide some general guidelines, but it would be difficult to announce the exact volume and calibration,” Luigi Speranza said.

The U.S. Federal Reserve announced Wednesday it would stop pandemic-era bonds purchases in March, and will raise rates three more times next year. It also makes life difficult for the ECB because the largest two central banks of the world are currently moving in different directions.

Most likely is for ECB policymakers to approve a bond purchasing quota, or “envelope”, for 2022. They will emphasize that this does not have to be spent.

The bank will also review exact volume and determine purchase goals for very short periods. It has been doing this in the recent months.

The bloc is likely to spend more on supranational debt in order to fund Next Generation EU spending. This project, which aids the recovery process, is the flagship of the bloc.

There is a risk of investors dumping bonds on the indebted peripheral, which could increase the borrowing costs for the governments.

The ECB may say that 100 billion euro of emergency funds could be still used to combat fragmentation. Cash from mature bonds and cash could be flexiblely used, which would allow the ECB to spend more on stressed markets.

The ECB also needs to deal with the problem of Greece. This country is most likely to stop bond purchases after the Emergency Programme ends.

Although all alternatives face legal challenges, the ECB may signal that reinvestments might be biased toward Greece. It will not however become eligible to buy new assets.

Berenberg stated in a note sent to clients, “Rarely has it been as uncomfortable or as uncertain for a significant ECB decision as it is now.”

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