There is likely to be a heated debate over the impact of the latest monetary policy strategy on short-term policy as policy commissioners decide on the impact of the ECB's two-day meeting on Wednesday.
The ECB raised its inflation target to 2 per cent earlier this month and promised to meet it "forcefully or firmly". The challenge is to explain what this strategy means for interest rates and bond purchases. Bloomberg reported last week that divisions broke out within the central bank immediately after the draft policy wording was distributed.
Lagarde, the central bank governor, raised expectations by promising "interesting adjustments and changes" in Thursday's policy statements and press conferences. She also admits that the consensus within the central bank won at the end of this month's strategic review may be hard to replicate.
When the situation is uncertain, the forward-looking guidance used by the central bank to describe the future policy trajectory has become an important tool. The aim is to prevent unwarranted market speculation from increasing volatility and damaging the economy.
While investors do not expect the central bank to immediately adjust interest rates or the two main asset purchase programmes, they want to know how these measures, their duration and intensity will change as the epidemic recedes.
The central bank pushes Qualcomm Inc in the face of economic recoveryThe inflationary situation insists it masks deep weakness and committee members must convince investors and the public that they will neither prematurely tighten policy, contain the recovery nor cause prices to spiral out of control.
interest rate
The ECB's strategic assessment identified interest rates as the main tool. Currently, interest rates in the euro zone are at historic lows, with deposit rates of-0.5%. Interest rate guidance is closely related to changes in inflation. While interest rate guidelines are sure to change to reflect the new targets, some economists are looking for more specific signals.
ABN AMRO analyst Nick Kounis expects the ECB to show that interest rates will remain at current or lower levels for longer than investors currently expect. Market pricing shows that the first 10 basis point rate hike is expected to take place at the end of 2023.
Jeffery's Marchel Alexandrovich expects the central bank to promise not to raise interest rates until 2023. "the ECB should not tolerate any ambiguity in the direction of interest rates over the next 18-24 months," he said in a report.
AXA Investment Managers's Gilles Moec said recent comments by Isabel Schnabel, the central bank's executive committee, suggested that interest rate guidance could be linked to real inflation rather than the central bank's outlook.
Asset purchase Program (APP)
The ECB's original asset purchase programme (APP) has been overshadowed by the 1.85 trillion euros ($2.2 trillion) epidemic Emergency purchase Program (PEPP). The two use similar strategies to drive down borrowing costs by buying bonds to ensure that interest rate spreads between stronger and weaker economies do not widen significantly.
BNP ParibasAnalysts such as Luigi Speranza said the most likely option would be to transfer some of the flexibility of the epidemic prevention bond purchase program to the asset purchase program, while continuing to commit to ensuring a favourable financing environment. This may include a commitment to accelerate purchases under APP (currently 20 billion euros per month) for at least a predetermined period of time or if certain conditions are met.
The ECB may also reconsider the order of eventual tightening. NatWest Markets economist Giovanni Zann and others believe that raising interest rates while continuing to implement QE is a "wise and welcome" move.
"this can be supported by all parties," they said. "it can take care of the demands of the countries in the north for higher interest rates, as well as the demands of the south to curb the spread of interest rates."
Anti-epidemic emergency bond purchase plan
PEPP is a temporary measure that is closely related to the current crisis, so there is little room to adjust its guidance in the medium term. The most direct way to express increased support is to pledge to use up 185 million euros. For now, the ECB says there is no need to use up all of it.
"another important point may be for the ECB to explain how to define the end of the 'epidemic crisis'," said ING's Carsten Brzeski. "will the eurozone achieve mass immunity, or will the economy return to pre-epidemic levels, or will the ECB's inflation forecast return to where it was at the end of 2019?"