Potential Change In ECB Policy And Inflation

By Orbex

Over the weekend there were media reports of a potential adjustment in ECB policy regarding its asset purchases.

At first glance, it appeared to be just talk of a mere technical change and could have passed unnoticed. It’s still in the “discussion” phase, so it’s quite possible that many traders ignored it.

The issue is that this particular topic could rile up differences between the “north” and “south”, along with a long-standing rift regarding monetary policy. If implemented, it could put the EU closer to the US in terms of the inflation outlook. Moreover, this could shift some of the balance of power within the EU.

So, unsurprisingly, if the discussion becomes serious, there could also be some severe pushback. So, it’s worth having a look at this in case it escalates from just media reports to an actual debate.

What’s at stake

According to FT, four ECB members said they would support increasing the amount of EU-issued assets that the ECB is buying as part of its PEPP program.

That’s a lot of jargon. Basically, the ECB’s emergency asset purchases supposedly cover a wide range of assets to support the economy and provide liquidity. Currently, they are only allowed to buy up to 10% of their purchases in debt issued by the European Union (the governing body).

The European Union only until recently has had the authority to issue debt to finance itself. The primary source of income for the Union is contributions from the member states.

However, they are moving to a model where the EU itself could levy taxes. This means that the EU would function more like a federal government on a fiscal level. This practically implies that the Union can issue debt and pay it back through taxes.

What that has to do with inflation

One of the ways to expand the monetary base is for governments to issue debt, spend the money, and then the central bank would buy the debt to provide liquidity.

This is a relatively common practice. In fact, “southern” countries highly favored this procedure before the euro. Effectively, it gives the government more spending power at the cost of higher inflation.

However, “northern” countries relying on fiscal surpluses and a strong currency are very much opposed to this kind of policy. The ECB so far has been using the “northern” policy model of maintaining price stability and expecting economic growth to drive inflation.

Nonetheless, the ECB has struggled to generate enough inflation, as the eurozone economy has languished in slow growth for the last decade or so. That could lead to some erosion of the strength of the “north” side.

Most notably, Lagarde is in favor of higher central bank investment in government debt – or at least that’s what she argued prior to becoming ECB chief.

Future implications

With only four out of 27 members of the monetary council in favor of the measure, it’s unlikely to advance at this point. This means that we are not likely to see any immediate moves in the euro or European stocks.

However, it’s one of those back-burner issues that could come to the fore if more members sign on to it. The mere fact that the ECB is discussing it could lead to internal tensions over policy.

Nevertheless, given the long-term implications, it would be surprising if someone from the ECB comes out soon to say that it’s just a rumor and the bank isn’t considering it seriously.

Article by Orbex

Orbex is a fully licensed broker that was established in 2011. Founded with a mission to serve its traders responsibly and provides traders with access to the world’s largest and most liquid financial markets. www.orbex.com