Shadow ECB Council: Council Sees Changes to Forward Guidance

Adjust the Growth/Deflation Risks

Most members agreed that growth risks have become more balanced and were no longer tilted to the downside. While inflation remains below the ECB’s target, most members also agreed there was no longer a risk of deflation (some members questioned where there ever had been). The ECB should adjust its opening statement to reflect that new reality, most members agreed. Yet many members said they believe low inflation in the euro zone remains a problem that must be addressed. Some noted the lack of strong wage growth, which had surprised to the downside and must be taken into account. One member noted the lack of deflation risks by itself means the ECB’s quantitative easing policy should be halted immediately.

Remove Easing Bias in Forward Guidance

A number of members suggested June could already be the time for some careful adjustments to the ECB’s forward guidance to move away from the central bank’s bias toward further easing. The ECB should eliminate its reference to the possibility of lower rates in future and instead reflect a more balanced outlook on the path of rates going forward. Not all agreed, however, with one member arguing there was “no reason” to remove the easing bias as early as June.

Members also broadly agreed the ECB should tweak its forward guidance when it comes to the sequencing of tapering. While all agreed the ECB should end its asset purchasing program before raising interest rates, most members said the central bank should remove its reference to interest rates being raised “well past” the end of APP to provide additional flexibility. In the words of one member, this was an “unnecessary time commitment” and the “well” reference should be removed from the statement.

Initial Signal on APP in September

Two members called for APP tapering to be implemented immediately, arguing the risks of deflation no longer existed and risks to financial stability outweighed the benefits of additional QE, and one member called for an immediate increase in the deposit rate to zero. A number of other members agreed the ECB’s policy may be excessively loose, and that financial-stability risks are growing (though few expressed fears of emerging asset-price bubbles), but said the ECB should continue its APP as advertised until the end of the year to avoid unnecessary market volatility. Still others believed the monetary stance remains appropriate. One member advocated shifting away from QE to the monetization of a sizeable fiscal stimulus focused on euro members with large output gaps as the only viable solution.

In nearly all cases, members believed some form of signal regarding its monthly asset purchasing program must come in September or (in the case of one member) October at the latest. Nearly all Shadow Council members agreed the ECB should signal its intention to start reducing the APP in 2018, though members differed on the pace and style of the announcement.

Tapering or Recalibration?

Some members called for a classic tapering that would see the APP program brought to a close at the end of the second quarter. Many members called for a more open-ended “recalibration,” announcing an additional reduction to €30 or €40 billion a month in the first quarter and leaving the rest of the year open-ended. While these members too believed a reduction to zero by the end of the second quarter is likely, such a recalibration would give the ECB greater flexibility/optionality to adjust the pace of the exit as it sees fit over time – or even increase the pace again should this be warranted by euro-zone economic data.

Frankfurt, 5th June, 2017
Jan Mallien and Christopher Cermak