More Cheap Money From the ECB?

ECB’s Governing Council member Villeroy de Galhau suggested that the central bank may be one of the last ones to taper. The euro was unimpressed, trading with a bid tone despite the dovish statement.

The main euro currency pairs are enjoying a bullish run in the last couple of months. The EUR/USD or the EUR/JPY keeps trending higher, mostly on the back of the euro’s strength rather than the dollar’s weakness.

Market participants expect that the G10 central banks will start trimming the asset purchases in the period ahead, as suggested by the economic growth triggered by the successful COVID-19 vaccination campaigns. But not all central banks will taper or normalise the policy at the same time, so market participants are speculating about which central bank will be the first or the last to lift the accommodative measures.

Judging by the bullishness of the euro, the European Central Bank (ECB) is expected to be one of the first central banks to taper. Yet, this is not the message sent by the Governing Council member Villeroy de Galhau yesterday.

No PEPP Reduction in Q3 2021

Villeroy, who is also the head of Banque du France, delivered a dovish message yesterday. He suggested that the ECB will be at least as patient as the Fed will be when it comes to tapering and called the idea of reducing the PEPP program in the third quarter of the year “purely speculative.”

Moreover, he implied that the ECB could remain in an accommodative stance way beyond the PEPP’s end. The tiering multiplier could be adjusted, and the deposit facility rate is not a floor, according to Villeroy.

Furthermore, and perhaps the most interesting take of his speech, referred to his view on inflation. According to the Governing Council member, the ECB can accept inflation above 2% for a while without seeing its mandate endangered.

This is a tricky statement because market participants are well aware that the Fed changed its mandate last year. It moved from targeting 2% inflation to averaging 2% inflation. If the ECB declares an inflation target symmetrical to the 2% on a yearly basis, it imitates the Fed’s moves.

According to Morgan Stanley, the cumulative price level shortfall compared to 2% target inflation in the last six years leaves plenty of room for the upside. In other words, to fill in the gap with the projected index when compared to the 2% target, the ECB should not taper but ease some more. Hence, Villeroy’s message should not come as a surprise, considering the shortfall with the 2% target.