Can the ECB Teach an Old Dog New Tricks?

The European Central Bank (ECB) has started unwinding its largest quantitative policy measure on record. While the process may seem clear, policy communications directed at investor behavior has been limited. What could that mean for the markets? Read on for our analysis.

In early 2014, the ECB began a major new policy, introducing negative rates and large-scale asset purchases in conjunction with more aggressive forward guidance on interest rates. The complementary policy pairing was designed to counter too-low inflation. Board member Benoît Cœuré said the ECB’s policy instruments were like the tail that wags the dogthe dog being long-term interest rates.[i]

At the time, one of the ECB’s problems was that term premiums were undesirably high, compensating investors for the possibility of rising rates. To help get expected future rates down, the ECB wanted term premiums to decline. This would mean lowering long-term yields on government bonds.

Nine years later — same dog, new tricks

In 2023, it appears the needed mix of measures and policy objectives has changed dramatically. Facing an environment of persistent above-target inflation, the ECB has begun shrinking its stock of balance sheet assets accumulated through the asset purchase programmes (APP).[ii] However unlike 2014, the nuance of signaling the ECB’s intentions for term premiums appears to be more complicated.