ECB set to leave rates unchanged and bring forward the end of Pepp. What to expect from the Governing Council on 14 December

Original version: Bce verso tassi fermi e modifiche al piano Pepp. Ecco cosa aspettarsi dal consiglio direttivo di giovedì 14 dicembre

The ECB Governing Council on Thursday will leave rates unchanged, while analysts say there could be indications of an early stop to reinvestments of Pepp bonds (now scheduled until the end of 2024). The outcome of the council meeting will largely be dependent on the communication of President Christine Lagarde, who will have to break out of the cage she has put herself in over the past few days with her statements on rates and Pepp.

It will be a tricky exercise because Lagarde has tied her hands before looking at inflation and growth trends, going against the ECB's data dependency. The latest numbers have shown inflation falling in the Eurozone more than ECB expectations and a still weak economy. Most economists believe that the eurozone will end up in recession in the fourth quarter. Therefore Lagarde will have to deal with the indications communicated in recent days.

The discussion on rates

On rates, the ECB president said in mid-November that there would be no cuts 'for at least two quarters'. But this form of forward guidance, indicated with the (failed) aim of hawkishly steering market expectations, clashed with what was later said by the hawkish Isabel Schnabel, the German member of the ECB executive board, who judged new rate increases 'unlikely' and did not rule out a cut in the first half of 2024. Thus Lagarde's statement was considered too harsh even by the hawks: in this sense it is likely that the president will have to adjust her stance, taking into account the German change of course and abandoning all forward guidance.

Schnabel's change of course

Why has Schnabel adopted a softer stance? One reason has to do with the drop in Eurozone inflation in November to 2.4 per cent, a fall that was unexpected by Schnabel who until a few days earlier was advocating a hard 'last mile' on prices. A second interpretation was provided by Charles Wyplosz, economist and professor at the Graduate Institute in Geneva, in an interview with Market News: "There is adistinct possibility that the combination of contractionary monetary policy now hitting contractionary fiscal policy might push Germany further down, which is precisely why Schnabel is now sounding more dovish," said Wyplosz noting that GDP could weaken and inflation fall more than expected forcing the ECB even to cut in 50 basis points steps. "The hawks have realised that this is not the soft landing and gradual decline in inflation they expected," he added.

The deterioration of the German economy, highlighted in recent days by the further decline in industrial production, should thus push the ECB to a less hard stance. Frankfurt will most likely cut its inflation and growth estimates on Thursday.

The Pepp discussion

At the same time, however, Lagarde will in all likelihood want to avoid sending too dovish messages, not least to counter market expectations of a rate cut being close, and will recall the ECB's focus on raising wages and labour costs. Inflation is expected to rise a bit for statistical effects at the end of the year. Further tightening could also come on Thursday through an early end to the reinvestment of Pepp bonds. Lagarde again went ahead and said that discussions on the programme would begin 'in the not too distant future'.

Analysts' expectations

Citi expects a decision immediately, beginning in March or April. According to Barclays, the ECB will announce its intention to phase out Pepp reinvestments starting in the second quarter. For BofA the ECB will discuss the pandemic plan on Thursday: the announcement could also come in January, with a start in April. Also for Bnp Paribas the ECB is ready to begin work on the Pepp with a start in spring. In general, the change will not entail a major tightening, although the reason for a restriction in this economic phase is unclear. Lagarde could also give some more details on the new ECB operating framework to be finalised in spring.

(Translated with Deepl)