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ECB May Need PEPP Flexibility for Future Stimulus, Villeroy Says

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(Bloomberg) — The European Central Bank should consider keeping some of the flexibility of its pandemic bond-buying program for future asset purchases, according to Governing Council member Francois Villeroy de Galhau. 

With inflation still seen falling short of the 2% target in the medium term, monetary policy will remain very accommodative even after the likely end of the 1.85 trillion-euro ($2.14 trillion) emergency scheme — known as PEPP — in March, the Bank of France governor said in a video speech to a conference. 

Villeroy sought to highlight how the ECB should try to preserve attributes of that program. PEPP is more flexible across asset classes and among jurisdictions than regular quantitative easing. It also isn’t set to monthly amounts, allowing policy makers to react to shifts in financial conditions when and where they occur.

“It could be worth examining if and how at least some elements of this PEPP flexibility should be kept in our ‘virtual’ toolbox,” Villeroy said on Tuesday. “Their mere existence, the theoretical possibility of their use, would mean that we would probably not have to actually use them.”

The comments hint at a likely fault line in the debate building at the ECB, where some of Villeroy’s colleagues are less open to the use of future stimulus on such terms. In an example of that reluctance, Estonian Governor Madis Muller said last month that “I don’t think we can take the flexibility that was there for PEPP and just transfer it.”

The ECB is already preparing for a transition to post-pandemic stimulus. It is studying a new bond-buying program to prevent any market turmoil once when emergency purchases end, according to officials familiar with the matter. 

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A decision is expected in December. Economists predict it will include an increase in regular monthly bond-buying.

“The Asset Purchase Program might benefit, still more than from increased fixed volumes, from adding some forms of flexibility of purchases over time,” Villeroy said.

The Frenchman added he’d be in favor of keeping targeted long-term loans to banks as a “liquidity backstop.” A “careful recalibration” of their terms is needed though, he said. Financial institutions currently get paid by the ECB if they fulfill certain lending requirements.

‘Rule Based’

Villeroy also said he’d support a “more rule-based approach” — considering changes in excess liquidity net of both necessary and borrowed reserves — when setting a tiering multiplier. 

The ECB started exempting some of banks’ holdings from its negative deposit rate two years ago to alleviate pressure on profitability.

Villeroy said growth in the euro area has been stronger than expected, and the economy is set to exceed its pre-Covid level by the end of the year. At the same time, uncertainty over the inflation outlook has increased.

Consumer prices are currently increasing at an annual pace of 3.4%, far faster than the ECB’s 2% goal. Officials have insisted that the spike is largely transitory, but recently started to warn that price pressures could also be more persistent.

Supply bottlenecks should fade over the coming quarters, Villeroy said, “but the exact timing is uncertain.” Moreover, there are only “few signs” a wage-price spiral that could feed inflation sustainably.

“From this point of view, it is clear that the risk remains that we fall short of our inflation target in 2023 rather than exceed it,” he said. “This calls for a continued accommodative monetary policy.”

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