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Monetary policy is very often a policy of words, and equally as effective. The President of the European Central Bank (ECB)'s latest speech demonstrates this perfectly. Speaking at the press conference following the Monetary Policy Committee on 9 September, Lagarde used the following words to illustrate the ECB's plans to slow the pace of asset purchases: “The lady isn’t tapering, she’s recalibrating”.
The markets took the news very well, as was expected, not least because of the President's artful choice of words: “recalibrate” has a much more positive ring to it than “reduce monetary support'”. But a reduction is precisely what it is: instead of buying almost EUR 80 billion in bonds every month under the Pandemic Emergency Purchase Programme (PEPP), the ECB is going to reduce this amount slightly. Or, rather – since “reduce” would again be too negative – the ECB will still buy, but at “a moderately lower pace”. But how much lower? We don't know. Would it be too shocking to say? Many anticipate the reduction to be in the order of EUR 10–20 billion a month.
Make no mistake, beyond the words, this is indeed a reduction in monetary support, at least under this programme (there are others). In this regard, the ECB (for once) is slightly ahead of the US Fed, which recently hinted that tapering was on the cards. Here, the taboo word is used correctly: tapering refers to the gradual reduction in monetary stimulus.
The implications of this recalibration could at first sight cause the markets to worry, but this doesn’t seem to be the case. Why not?
Firstly, recalibration is entirely appropriate at this stage of the economic cycle. Economic growth and inflation in the wealthier nations are showing unusual resilience. Both of these are resting on fragile foundations though, particularly since they are largely consumer-driven (also in the environmental sense). Levels remain compelling nonetheless. High inflation could prove to be more sustainable than anticipated, forcing central banks to tighten policy quicker than expected. This remains to be seen.
Secondly, there is at least one other, older purchase programme at the ECB: the Asset Purchase Programme (APP), currently running at a rate of EUR 20 billion per month, with no firm end-date in sight. It is possible, yet not guaranteed, that this scheme will pick up pace and compensate at least in part for the reduction in the PEPP.
Finally, even if this “recalibration” were to be of a vigorous nature, it is unlikely to completely change the flow dynamics of government bonds. This is because the major central banks now hold a considerable amount of their own countries’ (or zones’) sovereign debt: around 20% for the United States, higher for the eurozone and even higher still for Japan. The very fact that central banks reinvest maturing assets ensures that a significant part of governments' annual refinancing needs are met. So as long as central banks do not shrink their balance sheets – and there is absolutely no question of that happening at the moment – government financing will continue to be largely facilitated.
Does this mechanism run the risk of a tragic end? Probably not, because the more central banks engage in this logic, the more interested they become in maintaining it and coordinating with each other to avoid a systemic collapse. Thus, within this chronic, collective disequilibrium lies the foundation for a strengthened equilibrium – a truly great one at that.
Olivier de Berranger, CIO and Alexis Bienvenu, Fund Manager, LFDE