ECB executive Schnabel warns that QE is inflating asset prices

The negative side-effects of the European Central Bank’s bond-buying are increasing while its benefits are fading, one of its senior executives has said, warning that the policy is inflating asset prices and creating risks of financial instability.

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

Bond purchases increased “moral hazard” by making investors reliant on them, Schnabel said, adding they may cause “excessive risk taking and overvaluations”, as well as creating a shortage of sovereign bonds in some countries such as Germany.

Her comments are the latest signal that the ECB may only commit to maintaining its bond purchases for a short period when its governing council meets next week to decide on how much stimulus to provide next year.

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The central bank is expected to announce that it will stop new asset purchases in March under its €1.85tn Pandemic Emergency Purchase Programme (PEPP), launched last year in response to the pandemic.

Analysts have predicted that the ECB will cushion the impact on markets by expanding another, longer-standing asset purchase programme that it has kept running alongside PEPP. But the ECB may only commit to continue these purchases for a few months after March.

The decision has been complicated by the surge in eurozone inflation to a record high of 4.9 per cent in November. The ECB is almost certain to raise its 2022 inflation forecast to well above its 2 per cent target next week, making it harder to justify continuing to buy large amounts of bonds.

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

Since the ECB started buying bonds in 2015, it has built up a €4.6tn portfolio of assets. Analysts worry that any sign of a “hawkish” shift to withdraw stimulus earlier than expected could trigger a sell-off in eurozone bond markets.

Schnabel said “the euro area remains vulnerable to fragmentation” and any “unexpected policy adjustments” could cause “changes in financing conditions that are sharper than intended”. She added that the ECB could benefit from having “a credible backstop that commits to counter such risks of fragmentation”. 

Other ECB policymakers have suggested that the ECB could keep the option open of restarting asset purchases under the PEPP, if needed, to counter market disruption. Schnabel said the scheme, which gives the bank extra flexibility in the timing and type of purchases, had “effectively provided such a backstop function over the course of the pandemic”. 

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

She also said there was little point in raising interest rates in response to the “adverse supply-side shocks” that have pushed inflation above the ECB’s target this year. This would “risk choking the recovery and, given the long lags in transmission, exert downward pressure on inflation at a time when the shocks are likely to have already faded”, she said.

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