Aurelia Butler

The writer is a member of the executive board of the Deutsche BundesbankRising inflation has been a game-changer for central banks. A few years ago, when inflation was stubbornly low despite a series of interest rate cuts, central banks expanded their toolkit to lift inflation. This resulted in asset purchases in the trillions of euros. With inflation accelerating to historic highs in 2022 and policy rates rising, the time has come to reverse this extraordinary measure. Monetary policy purchase programmes of the Eurosystem — that is the European Central Bank and the central banks of the 20 member states — originate from an environment of inflation well below the 2 per cent target combined with historically low interest rates. To fulfil the price stability mandate, negative side effects were tolerated at the time.The consequences of the significant market footprint resulting from our purchase programmes — roughly 40 per cent of public debt is in the hands of the Eurosystem — are increasingly visible. Collateral scarcity in the market for German government bonds is a significant distortion. The crowding out of traditional investor groups, for example in the market for asset-backed securities, represents another side effect. Finally, a prominent and lasting role of central banks in corporate and covered bond markets can impair market liquidity and alienate issuers from their traditional investor base. As a general principle, central banks should only intervene in financial markets to the degree necessary for monetary policy purposes.Today, we are facing different circumstances from those when the asset purchase programme (APP) started. Excessive inflation calls for a determined response, which we are pursuing in the Eurosystem. The key policy rates are our primary instrument to steer monetary policy on that course. The reduction of our balance sheet supports this restrictive path across the yield curve. The time has come for the Eurosystem to scale back its market presence.The Eurosystem will start reducing its market footprint by decreasing its APP portfolio holdings by an average of €15bn a month between March and June 2023. This amounts to approximately 50 per cent of the expected redemptions in its APP holdings during this initial phase of balance sheet normalisation.From a market functioning perspective, there are good reasons for such a measured approach. First, financial markets have experienced high volatility and rising yields since early 2022, stretching the risk budgets of many investors in fixed income markets. Second, the ease of absorption of higher bond volumes will probably remain closely linked to the outlook for inflation and to the expected interest rate path. Last, an over-proportional share of this year’s elevated bond issuance in the euro area is likely to hit the market in the first half of the year.By decreasing our balance sheets, we enter the territory of quantitative tightening, for which there is plenty of theory but relatively little practical experience to draw on. This is a challenge for central banks and market participants.Still, there is already growing evidence of investors returning to fixed income markets. Higher yields and coupons are creating incentives and opportunities — not only for structural buyers such as insurers or pension funds, but also for more price-sensitive investors. Many institutional investors, who have added to the most illiquid parts of their portfolios over recent years (such as real estate and infrastructure), may now be taking a closer look at eurozone fixed-income assets again. Moreover, US dollar-based investors — among others — are enjoying additional incentives to invest in euro assets due to favourable FX hedging mechanics. All in all, I am optimistic that a predictable and clear withdrawal of the Eurosystem from its APP holdings will support our fight against inflation without triggering market turbulence. The Eurosystem will reassess the speed and scope of its actions in early summer and, in doing so, could well consider a more ambitious future path. More

The fracturing of the global trading system was the subject of much earnest debate last week at Davos. Taking centre stage was how the EU would respond to the contentious US Inflation Reduction Act — a $369bn package which aims to stimulate its green energy and electric vehicle industries. European Commission president Ursula von der Leyen weighed in with plans to temporarily water down state aid regulations and pump cash into strategic climate-friendly businesses. Her announcement underscored a new era of green and technological rivalry between the major trading partners. How healthy that contest will be, not just for them but for the global economy, will hinge on whether both can co-operate in setting the rules of the game.Since the IRA was passed in August, it has drawn concern in Europe. It contains elements that are an affront to free trade — even if these were a product of horse-trading to get the bill through rather than a deliberate aim. But it is also unapologetically ambitious in channelling funds rapidly towards tackling climate change, something the EU has long urged the US to do. Both of these elements, and the competitive threat to European industry, added pressure on the EU to start pulling together its own response. The IRA was, no doubt, a wake-up call for Europe to go further on its existing climate change efforts, but if the collateral damage is a collapse in the US and EU’s relationship, and a race to the bottom on competition rules, it will come at a severe cost.The biggest bones of contention over the IRA are subsidies and tax credits for US-manufactured products ranging from solar panels to electric vehicles. The domestic content requirements appear to run counter to the World Trade Organization’s rules on trading without discrimination. They skew the competitive playing field, encourage self-sufficiency and risk inspiring a retaliatory subsidy race in kind. Where such discrimination prevails it attracts production to where it is less efficient, while the innovative hand of competitive forces from imports would be subdued, which would undermine domestic strategic aims. In a splintering geopolitical environment, the US and EU need to be working together and not engaging in a wasteful battle to draw business and investment away from each other. (The EU also needs to ensure a level playing field within its own internal market.) A fallout on trade risks stifling EU and US collaboration on issues of global importance, including climate change, debt distress and the stance towards China. Subsidies are nonetheless set to play a big part in how both shore up efforts to reduce emissions, harness new technologies and support national security, which makes co-operation vital. Avoiding distortionary subsidies, and having clear rules on the boundaries of what support is acceptable, is key. Reform of the WTO would be a starting point but given its broad membership and the US’s blockage of appointments to the appellate body, that will not be straightforward. This places greater emphasis on regular bilateral dialogue between the US and EU to help avoid the risk of hobbling each other or sparking undesirable competitive practices. Negotiations for EU exemptions to the IRA’s domestic content requirements for electric vehicle batteries, among other issues, are at least taking place and offer hope of collaboration. Navigating the line between supporting domestic goals while avoiding beggar-thy-neighbour measures will be challenging. Success will depend on the strength of dialogue over the ground rules. As the EU trade commissioner Valdis Dombrovskis said in Davos, the EU and US should be “building transatlantic value chains, not breaking them apart”. More

“Expect us to raise rates by 0.5% in February and March and expect us to not be done by then and that more steps will follow in May and June,” Knot said.In a separate interview with Italian newspaper La Stampa published on Sunday, Knot said it was “too early to tell” if the ECB could slow down the pace of its rate increases by the summer.”At some point, of course, the risks surrounding the inflation outlook will become more balanced,” he said.”That would also be a time in which we could make a further step down from 50 to 25 basis points, for instance. But we are still far away from that.” More

TOKYO (Reuters) – Japanese Prime Minister Fumio Kishida said on Sunday he would nominate a new Bank of Japan governor next month, as markets test whether the central bank will change the ultra low-rate policy of the dovish Haruhiko Kuroda.Kishida initially told a TV Tokyo programme that he would decide on Kuroda’s replacement by considering the economic situation for April, but when pressed he acknowledged this would likely be in February, “considering parliament’s schedule.”He did not elaborate.Kuroda, whose five-year term ends on April 8, has stuck with policies aimed at stoking price rises and growth, even with inflation at 41-year highs and double the BOJ’s target, and as central banks elsewhere have been raising interest rates.The terms of Kuroda’s two deputies end on March 19. The three nominations must be approved by both houses of parliament.The BOJ stuck to its ultra-easy policy on Wednesday, defying investors who have recently sought to break the bank’s cap on the 10-year government bond yield. But with even Kuroda sounding bullish about wage rises, expectations are growing that the BOJ will end its expansionist experiment this year.Last week’s test followed the BOJ’s surprise December decision to double the target band for the yield to 0.5% above or below zero.Former BOJ board member Sayuri Shirai, an advocate of reviewing the current stimulus who is considered a candidate for deputy governor, said on Sunday the BOJ should make its government bond buying more flexible but that low interest rates are warranted.There is also speculation about changes to a policy accord between the central bank and the government, in which the BOJ pledges to achieve its 2% inflation target as early as possible.Kishida said it was too early to comment on whether the accord needed to be altered but said there will be no change to the “basic stance” that his government and the BOJ work together “to achieve economic growth that involves structural wage hikes and reach the price-stability target stably and sustainably”. More