Will the ECB Also Introduce Tapering?
October 27, 2021
Will the ECB Also Introduce Tapering? It's a more than legitimate question considering what's brewing in the United States. The Fed is preparing to implement a new phase of monetary policy, focused precisely on the gradual reduction of quantitative easing.
The topic is complex, just as it is complex to produce more or less realistic estimates of central banks' behavior. After all, although the world's two largest monetary institutions often aim for convergence, their respective national and supranational contexts have different characteristics, in some cases even in antithesis.
It's worth analyzing these contexts and drawing some insights from this analysis to try to understand future moves.
The Current Monetary and Economic Context
Currently, both the ECB and the Fed are engaged in massive securities purchase programs. This is not surprising, considering the impact of the pandemic not only on a social level but also economically. From this point of view, quantitative easing was not a choice resulting from a clear vision, but a necessity.
However, the differences between the two programs should be noted. As you surely already know, the Federal Reserve's quantitative easing is much more impressive than that of the ECB, even considering the objective difference between the American and European economic systems. Moreover, the Federal Reserve's quantitative easing has a more direct character compared to that of the European Central Bank.
Again, this should not be surprising. These differences in approach are influenced by the more conservative nature of the ECB, historically reluctant to directly finance national treasuries.
As many had predicted, the peculiar economic situation determined by the pandemic and the presence of such expansionary monetary policies has also generated negative effects on the economic system. In simple terms, it has caused an increase in inflation.
This increase has proven to be much more severe in the United States than in Europe. After all, the old continent started from a more disadvantaged (or advantageous, depending on the point of view) situation. The reference is to the long-standing tendency of European economies to fall into disinflationary or deflationary spirals.
In addition to the price issue, there is also the economic recovery, which in some areas is even rampant. This signal, in theory, should suggest a tightening of monetary policies.
In this panorama, it appears entirely justified to reflect on the progressive abandonment of quantitative easing or its radical permanent reduction. In the United States, this reflection is about to result in a concrete stance by the Federal Reserve. It is almost certain that tapering will be introduced by the end of the year. In short, it's only a matter of time.
Will it be the same for the European Central Bank? Logic would suggest so, and besides, the monetary context (rising inflation) and economic context (recovery at an accelerated pace) is quite similar to the American one.
Let's try to clarify.
The ECB's Plans
The issue is more complex than one might imagine for a fairly simple reason: the European Central Bank does not have just one securities purchase program to its credit, but two: quantitative easing proper, which runs at a rate of 20 billion per month; the PEPP, specifically designed to manage the pandemic, which runs at a rate of 80 billion per month, although it is objectively characterized by greater flexibility.
Those expecting tapering, therefore, should first of all understand which of the two purchase programs could be involved, or if the reduction program could concern both.
In reality, the PEPP has a precise expiration date. It is set for March 31, 2022. It is not a date set in stone, also because the European Central Bank's board has repeatedly expressed the view that monetary policy should follow the needs of the economic and financial context rather than a rigid schedule, given the turbulent and uncertain times we are living in.
One might wonder, rather, if the PEPP will be renewed even beyond its natural expiration.
Corridor rumors seem to already have the answer. According to the Financial Times' reconstruction, the European Central Bank is reportedly considering measures to support impressive monetary stimulus even after the "natural" death of the PEPP.
Nothing particularly creative: the board is reportedly considering an increase in true quantitative easing. Indeed, 20 billion per month might seem too little to sustain a recovery that is accelerated, yes, but does not appear particularly solid. All this, net of fears about inflation, which is certainly a little higher than hoped for, but still far from the alarming levels recorded in the United States.
The "new" ECB-branded quantitative easing should aim to purchase securities admitted by European institutions, and be framed within the more general recovery fund plan.
In short, it is still all to come, but the current orientation suggests a European monetary policy different from the American one. If the Federal Reserve is thinking about tapering, the ECB is even thinking about strengthening quantitative easing, which should at least replace the nearly defunct PEPP.
The Effects of Monetary Policies on Forex
If the Financial Times corridor rumors were confirmed, what would be the impact on Forex, or rather on the euro-dollar exchange rate?
Obviously, no one has a crystal ball. In any case, numerous factors are at play, some of which are imponderable or difficult to predict.
Following a purely theoretical line, however, it would not be blasphemy to imagine a decreasing euro-dollar. The Federal Reserve's future tapering should in fact give an upward push to the dollar.
A push that would not be at all offset by the European Central Bank's monetary policies, which (again according to the Financial Times) would not be considering a significant tightening of monetary stimulus.
Mind you, from here to pulling out again "the dreams of euro-dollar parity" is a long way off. Also because currently the exchange rate is currently above 1.10 (end of October 2021)
Certainly we will know much more in a few weeks, when the Federal Reserve will have by now made known the extent and timing of tapering, and the European Central Bank's corridor rumors will have turned into confirmation or denial.
