(Bloomberg) -- The European Central Bank will likely keep rates at 4% for a few quarters and may wind down its Covid bond-buying portfolio earlier than planned, Governing Council member Francois Villeroy de Galhau said, pushing back against expectations for a hasty loosening of inflation-fighting measures.
The French central banker said that even if the dis-inflationary trend in the euro area is “solid,” and “somewhat quicker” than expected, investors have shifted too quickly from asking when rate hikes would stop to asking when the central bank will cut.
“In a mountainous environment, there aren’t just peaks and descents: there are also plateaus, where you can experience the effects of altitude and appreciate the view,” he said in a speech at the Society of Professional Economists in London. “That’s what we’ll probably be doing for at least the next several meetings and the next few quarters.”
Villeroy also said the ECB could discontinue “possibly earlier than the end of 2024” the reinvestments from the €1.7 trillion ($1.8 trillion) PEPP bond portfolio, which was initially designed to fuel inflation during the Covid pandemic. The institution’s current guidance is it to keep reinvesting until at least the end of this year.
The indications of the ECB’s stance in the coming months come as traders have been reluctant to pare more dovish bets on interest-rate cuts next year, even as policy makers — many of them more hawkish than Villeroy — have stressed the central bank’s message last month that it will stay at 4% for a “sufficient period.”
Markets see a 70% chance of a first quarter-point cut in April and more than 90 basis points in total through 2024, according to swaps tied to central bank meetings.
“Expect our next meetings to be a bit more boring,” he said. “But if this is synonym for somewhat reduced uncertainty and intelligent patience before future rate cuts, nobody should regret it.”
While Villeroy indicated that rates will be at a plateau for longer than investors currently expect, he refused to give any concrete guidance on when a first cut may happen. According to the French central banker, the ECB has previously given forward guidance that was probably too rigid and excessive in principle, especially when faced with large, unexpected shocks.
“In the future, I wouldn’t rule out a return to some form of forward guidance, but seen as more indicative, more state-dependent and more modest – i.e. less powerful as an instrument,” Villeroy said.
For interest rates, he said the ECB will have “intelligent patience” and the key criteria for an eventual cut will be securing an inflation outlook that is ‘’firmly and durably” compatible with the 2% target. For the situation to be considered durable, he said that the ECB would require a forecast of 2% inflation ahead of its horizon for projections, and a decline toward that rate for household and business expectations.
“The ECB will bring inflation back toward 2% by 2025,” Villeroy said. “This includes some judgment: I am not fixated on 2.0% to the nearest decimal place and I am not obsessed by the alleged challenge of ‘the last mile.’”
In a similar vein to the indications on rates, Villeroy avoided committing to when the ECB could pare back the PEPP portfolio of bonds, saying there is no reason to commit to a specific order of sequencing.
“We have to expect more volatility in global bond markets, more decoupling of short term and long term rates and we will need to pragmatically take account of the implications for our domestic monetary policy,” Villeroy said.
--With assistance from Alice Gledhill and Lucy Meakin.
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