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ECB – Schnabel dives into historic low real rates

After an analysis of inflation dynamics on Monday we now have a dive into explaining historic low real rates in the latest speech on Wednesday from ECB Isabel Schnabel. The puzzle is that real rates would be expected to rise given unprecedented fiscal and monetary policy support, large public infrastructure programmes, and a strong push toward a greener/digital economy. Instead, they have fallen to record lows. Two explanations are offered 1) the spread of the Delta variant; and 2) the impact of monetary policy.

On the first of these factors (Delta variant) Schnabel says, “The market may be overestimating the risks to the global growth outlook from the spread of the more contagious Delta variant”, pointing to consensus expectations for growth in 2022 that have “remained unscathed” and fund managers survey that show only 3% seeing Covid-19 as a significant growth risk. The Delta explanation is more of a puzzle given the rally in equity markets that are mostly explained by revisions to longer-term earnings.

In contrast, the second of the factors (monetary policy) is described by Schnabel as a non-puzzle. Asset purchases and a perceived change in the ECB/Fed reaction functions are delved into when explaining the move lower in real rates. We will touch on these aspects in future comments later this week.

Schnabel concludes that the record low rates provide “substantial policy accommodation” that supports the recovery and paves the way for inflation to reach 2%. She adds that “the stock of acquired assets as well as our new forward guidance are contributing to keeping real yields anchored at low levels”. The use of the word “substantial” is important in the context of an ECB that has started the process of reducing PEPP purchases to ‘normal’ levels and is likely to embark on a tapering exercise in Q1 2022. It suggests that the ECB would be comfortable should policy accommodation be less substantial, and thus for an end to PEPP not to be fully reflected in an increase in APP.

Heading into December we see two likely outcomes in terms of how markets see policy evolving 1) the APP will be increased to €40bn in order to help offset for an eventual end to the PEPP, but given the recovery in inflation/economy and favourable financing conditions, it does not need to fully compensate; and 2) for the APP to embed some of the flexibility of the PEPP programme so that it can continue to be seen as a credible instrument.
Source: Reuters (Reporting by Divyang Shah)

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