ECB executive Schnabel warns QE inflates asset prices

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The negative side effects of the European Central Bank’s bond purchase are increasing as its benefits wear off, one of its top executives has said, warning that the policy inflates asset prices and creates downside risks. financial instability.

Isabel Schnabel, the ECB executive responsible for market operations, noted asset purchases were “an important tool” in times of market turmoil or recession, “but their cost-benefit ratio deteriorates as the economy gains ground.”

Bond purchases have increased “moral hazard” by making investors dependent on them, Schnabel said, adding that they could lead to “excessive risk-taking and overvaluation”, as well as a bond shortage. sovereign in some countries like Germany.

His comments are the latest signal that the ECB may commit to only maintaining bond purchases for a short time when its governing council meets next week to decide on the level of stimulus to provide next year.

The central bank is expected to announce that it will stop further asset purchases in March as part of its € 1.85 billion pandemic emergency purchase program (PEPP), launched last year in response to the pandemic.

Analysts predicted that the ECB would cushion the impact on markets by developing another longer-lived asset purchase program that it continued to execute alongside the PEPP. But the ECB might not commit to continuing these purchases until a few months after March.

The decision was complicated by the surge in euro area inflation to an all-time high of 4.9 percent in November. The ECB is almost certain to raise its inflation forecast for 2022 well above its 2% target next week, making it harder to justify continuing to buy large amounts of bonds.

“By gradually shifting the policy mix from net asset purchases when monetary policy goals are within reach, central banks can effectively mitigate financial stability risks,” said Schnabel.

Since the ECB started buying bonds in 2015, it has built an asset portfolio of 4.6 billion euros. Analysts fear that any sign of a “hawkish” move to withdraw the stimulus earlier than expected could trigger a sell-off in eurozone bond markets.

Schnabel said that “the euro area remains vulnerable to fragmentation” and that any “unexpected political adjustment” could lead to “changes in financing conditions that are more pronounced than expected”. She added that the ECB could benefit from a “credible backstop which undertakes to counter such risks of fragmentation”.

Other ECB policymakers have suggested that the ECB could keep the option of restarting asset purchases under the PEPP, if necessary, to counter market disruptions. Schnabel said the program, which gives the bank additional flexibility in timing and type of purchases, had “effectively provided such a supportive function during the pandemic.”

The German economics professor, who joined the ECB’s board almost two years ago, rejected the idea that the bloc’s central bank could raise interest rates before stopping purchases of assets.

She also said there was no point in raising interest rates in response to “adverse supply-side shocks” that have pushed inflation above the ECB’s target this year. This would “risk stifling the recovery and, given the long transmission delays, put downward pressure on inflation at a time when shocks are already expected to subside,” she said.

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