ECB Officials Prepare for Clash of Clans on Next Stimulus Move

(Bloomberg) — Battle lines are being drawn at the heart of the European Central Bank over whether to add monetary support soon to head off any economic slowdown, or wait for stronger evidence that it’s needed.

Executive Board member Fabio Panetta raised the prospect of a preemptive burst of stimulus last week when he said “the risks of a policy overreaction are much smaller than the risks of policy being too slow or too shy.”

That echoes Chief Economist Philip Lane, who has suggested more must be done to revive inflation even if the worst of the economic crisis has passed. He said on Twitter last week that “ample” stimulus is still required.

chart, line chart: ECB's inflation goal is `below, but close, to 2%'

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ECB’s inflation goal is `below, but close, to 2%’

Yet their colleague Yves Mersch, who steps down in December, said in a Bloomberg interview that the downside risks have lessened and he sees no deterioration in output or prices. He even said a huge improvement in the outlook should prompt the “opposite” of monetary easing.

“There is some sort of a clash of clans boiling under the surface between those who want to act pre-emptively and those who prefer to be reactive,” said Frederik Ducrozet, chief strategist at Pictet & Cie in Geneva. “Every time we are in a gray area, we may see this type of conflict return.”

a man wearing glasses: Key Speakers At The ECB And Its Watchers Conference

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Key Speakers At The ECB And Its Watchers Conference

Yves Mersch


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Photographer: Andreas Arnold/Bloomberg

Divergent views on the six-member board may be at an early stage, but they augur potential disputes in the decision-making Governing Council. Mersch’s opinions could find support there from policy makers such as Bundesbank President Jens Weidmann, who has already warned against relying for too long on the 1.35 trillion-euro ($1.6 trillion) pandemic bond-buying program, and Austria’s Robert Holzmann.

Tricky Phase

The ECB is entering an especially tricky phase in its crisis response. Financial markets have stabilized and the economy is growing again, but the rebound is uneven and inflation is languishing below zero. Pump too much liquidity in and it risks destabilizing the financial system, yet do too little and the recovery could crumble.

Most economists predict the pandemic program will be expanded this year, probably in December when new economic projections are published. Any sign that might not happen could cause investor unease that tightens financial conditions.

“It’s very difficult environment to operate in with lingering uncertainties,” said Piet Christiansen, chief strategist at Danske Bank A/S. “The problem with disagreement and compromises is that it won’t lead to a strong policy response compared to the situation where you have unanimity.”

Read more: ECB Should Maintain Significant Monetary Stimulus, De Cos Says

Pivotal to how the debate proceeds is ECB President Christine Lagarde, who joined 11 months ago promising to be a consensus-builder after disagreements on the Governing Council under her predecessor, Mario Draghi.

So far she’s been cautious, saying last week that “the uncertainty of the current environment requires a very careful assessment of the incoming information.” She appears before the European Parliament on Monday.

The two other members of the board, which designs and proposes monetary policy, are also being circumspect in public. Isabel Schnabel has echoed Lagarde in saying more information is needed. Both she and Vice President Luis De Guindos have stressed that while the ECB can and will act if needed, fiscal support is critical.

The ECB’s economic projections — which assume a “medical solution” to the virus in mid-2021 — include huge variability, covering three scenarios from mild to severe.

chart: Uncertain Times

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Uncertain Times

chart, bar chart

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The central bank said this month that the upturn is in line with its baseline projections but the risks “remain on the downside.”

Since then, infections have jumped — as Mersch acknowledged — yet governments are trying to avoid the national lockdowns that caused this year’s record recession. Data last week showed manufacturing improving while services are shrinking again.

a man wearing a suit and tie looking at the camera: Federal Reserve Jackson Hole Economic Symposium

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Federal Reserve Jackson Hole Economic Symposium

Fabio Panetta

Photographer: David Paul Morris/Bloomberg

Moreover, the inflation rate is below zero for the first time in four years, and isn’t expected to return to the goal of “below, but close, to 2%” for a long time. Even that target is being reassessed, following in the footsteps of the Federal Reserve’s strategic review, adding to the uncertainty.

“Much will depend on how the data evolve over the next 2-3 months,” Greg Fuzesi, an economist at JPMorgan Chase & Co., said in a report for clients. “The differences between Panetta and Mersch suggest that the Governing Council is only at the beginning of the next consensus-building process.”

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