By Francesco Canepa and Balazs Koranyi

FRANKFURT (Reuters) – European Central Bank policymakers are bracing for inflation to exceed the bank’s already raised estimates, paving the way for it to end its emergency bond purchases in March, sources involved in the discussion said.

The ECB will make a decision in December on its Pandemic Emergency Purchase Programme. They expect inflation to fall in 2022 and 23 after the year’s unexpected bounce. This is as the economy returns back to normal.

Conversations with eight members the ECB’s Governing council who chose not to be named revealed that they felt the revised forecasts of inflation being at 2.2% this, 1.7% next and 1.5% 2023 were far too low.

Since then, data has reinforced their fears that inflation may be near or even exceeding the ECB’s 2% inflation target next years. This could cause problems since ECB policy rests on inflation not reaching the target in the future.

Sources pointed out that supply disruptions were longer than anticipated, staff shortages that extended beyond the hospitality industry and a constant stream of cash flowing into the economy via private savings and government stimulus programs – including the ECB.

While the discussion was just beginning, most sources agree that inflation has strengthened an already compelling case to end PEPP. It is estimated at 1.85 trillion euro.

To avoid the “cliff effect”, many were open to temporary increases in central bank’s bond-buying program, the Asset Purchase Programme.

Some people said that they were willing to accept APP operating at a faster pace than the 20 billion euro per month, provided it was clear about its end date.

Some at the more conservative end of this spectrum considered 40 billion too high, considering that the government’s debt is expected to fall sharply in the next year.

According to sources, many policymakers are also willing to let the ECB buy bonds outside of its country quotas. This could be a win for debt-ridden governments like Italy that come under increasing pressure from the financial markets.

However, there was widespread opposition to changing the issuer limitation – a limit on how many bonds the ECB can hold from a single country. It has been used as a shield against claims that the central bank is funding governments.

Germany was within striking distance of making the issuer limit binding.

The ECB did not respond to requests for comment.

MORE EVIDENCE

All sources said it was too early to draw any definitive conclusion about the economic outlook and its policy implications.

Two seminars were scheduled for policymakers in the next weeks. The first was about the ECB’s long-term loans and purchases of assets.

More evidence is needed to prove that an inflation “hump”, which was higher than the average, would result in the kind of price increases the bank wanted. This was especially true since wages growth was still low.

However, they were worried about the ECB’s macroeconomic models that predict the future based only on the past. They are skewed due to years of slow price growth, and underestimate the impact of global changes since the beginning of the pandemic.

The ECB stated that it expects supply chain bottlenecks in the next year to be less severe and some commodities prices to rebound, lowering inflation after a brief but temporary rise.

It wouldn’t be hard for this to happen, but some doubters believe it would. Some expressed their dismay at the ECB President Christine Lagarde’s and Chief Economist Philip Lane’s insistent on the temporary nature the rise.

We believe that the rise in inflation is mostly temporary. One source said that largely does not mean completely. A small amount of these transitory variables is needed to stay around to close the gap between the forecast and target.

On Wednesday, the U.S. Federal Reserve highlighted their concern about inflation and raised its own projections, projecting price growth to be at or higher than its 2% target over many years.

Markets anticipate that the ECB will wind down PEPP by March. However, it will continue to buy bonds under its Asset Purchase programme while keeping its deposit rate at –0.5% for the next three years.

($1 = 0.8524 euros)