Mike Dolan

LONDON (Reuters), if the major central banks around the globe are confident that the global economic crisis is over, and that policy should return to pre-pandemic levels, then the ECB will likely beat the Fed.

The highest inflation rate in many decades is due to distortions and bottlenecks resulting from rapidly opening economies following serial COVID-19 lockdowns. Central banks are concerned that these rates may not subside as quickly as first believed.

Omicron’s wave at year-end muddied again the economic picture. It could prolong supply chains and create labour market distortions, which will keep inflation rates higher longer. This increases the chance of these factors becoming embedded in expectations for workers, households, and companies.

If there is any doubt, then stop adding stimulus and return to square 1. Then, assess the terrain.

Officials at the U.S. Federal Reserve have set their sights on 2022. They insist that they won’t stop buying bonds until March. The first three or more interest rate increases this year, at minimum, will occur at that time. Unwinding the Fed’s overinflated balance sheet will follow shortly thereafter.

Jerome Powell, Fed chair, talked Tuesday about normalizing Fed policy but being humble and agile.

Even though the European Central Bank’s situation is slightly different, they are still dealing with an inflation problem and communication problems. Their top executives have sent a message of caution regarding inflation risks as well as a reaffirmation of their central price stability mandate.

Philip Lane, Chief Economist at the ECB said this week that he expects inflation to fall below 2% in 2019 and 2024. Christine Lagarde expressed her “unwavering” commitment towards stable prices on Tuesday. Joachim Nagel, new Bundesbank boss, said that he fears inflation may remain high.

Many in the market will face a slower economic recovery, greater jobless rates, and aging demographics that threaten deflation for a decade. The ECB will remain deeply dovish longer than the Fed.

A swoon of almost 10% in the Euro/dollar currency rate during the second half last year is an example of some of these.

Pre-pandemic, ECB benchmark sovereign bond yields and ECB policy rate were both negative. Its accumulated balance is twice as large as the Fed’s nominally, and has more than 65% of the gross domestic product of Washington.

Marco Valli, UniCredit’s economist points out that much of the ECB’s stance existed before the pandemic.

He wrote that “When you take into consideration the various starting points for monetary policy, the ECB’s stance appears less dovish”

HUMBLE AND NIMBLE

Valli believes that based upon its Dec. 16 decisions – which aims at winding down emergency pandemic bonds buying stimuli by March and ending new special lending facilities for June – the ECB will be returning to pre-pandemic levels by October. This is one year before the Fed on their existing plans.

Of course the Fed reduced its policy interest rate more than 150 basis point and rebuilt its net bond buying when COVID struck. As its main support for long-term interest rates, the ECB relied heavily on the PEPP Bond Purchase Programme. The ECB’s repo rates were already set at 0% in 2016; its current deposit rate is -0.5%.

Valli said that it was still important to note that the ECB would return to pre-COVID levels before the Fed, despite less labor market distortions feeding wages and weaker exchange rates on import prices. There will also be less concern about equity valuations.

Either that the Fed has been slow to normalize – which, judging by the frantic speechifying of Fed officials this year suggests it – or that the ECB is being cautious.

Valli stated that the former seems more probable.

Most economists believe that a slight 10 bp increase in ECB deposits rates at year’s end is too high despite market pricing.

Deutsche Bank (DE:). Tuesday’s House View published by the House says that this liftoff is not likely until 2023. However, it shows net asset purchases falling by around 70% this year.

Contrarily, even though the Fed raises rates 4 times this year as the market prices suggest, they would remain well below their pre-pandemic level.

The Fed could reduce its balance sheet quickly this year, which would increase relative stances. However, shrinking the ECB seems a longer distance away. However, Powell from the Fed stated Tuesday that there had not been a decision yet.

While the ECB is more tortoise than the Fed-like Fed in appearance, it might also be able to win the race. It’s not clear if this is a positive outcome for the Euro zone economy.

The editor-at-large of finance and markets for Reuters News is the author. These views are solely his.

(by Mike Dolan; Twitter (NYSE): @reutersMikeD Edited by Alexander Smith