Weidmann: Monetary policy normalisation process should not be put off

In a speech held at the Centre for European Economic Research in Mannheim, Bundesbank President Jens Weidmann spoke out in favour of bringing net asset purchases in the euro area to a swift end. This, he stated, would only be the beginning of a lengthy process of monetary policy normalisation. "It is precisely for this reason that it is so important not to put it off for much longer."

In addition, Mr Weidmann said that normalising monetary policy would give policymakers leeway again to respond to any economic slumps in the future – "because the current upswing won’t last forever," he warned. At the same time, he believes that concerns over the upswing coming to an end are exaggerated. Following extremely high growth last year, Mr Weidmann said that the slowdown in economic activity at the start of this year should not be understood as a turning point in economic activity but as a dent in an upward trend. However, he added that the protectionist tendencies currently observed were worrying, remarking that "these tendencies really do pose an economic risk – and yes, ultimately also to growth and welfare".

Forward guidance a key instrument

Mr Weidmann’s speech detailed the importance of communication as an instrument of monetary policy, particularly forward guidance. This is a form of central bank communication that provides information about the future path of monetary policy.

Mr Weidmann explained that the forward guidance issued by the ECB Governing Council currently contains two statements pertaining to the start of the monetary policy normalisation process in the euro area. First, it announces that even after the net purchases have ended, the principal payments from maturing securities will be reinvested "for an extended period of time, and in any case for as long as necessary". Second, it conveys the expectation that key interest rates will remain at their present levels "for an extended period of time, and well past the horizon" of the net asset purchases. To the Bundesbank President, this rather vague wording raises the question of if and when the exact point in time should be specified.

According to Mr Weidmann, economic developments in the euro area at the start of the normalisation process will presumably be far ahead of those in the United States when it went through the same process. "The first interest rate increase could therefore happen much sooner after net purchases end than was the case in the United States," he remarked. In the United States, he said, a little more than a year passed between the end of the asset purchases and the first interest rate hike. Bearing this in mind, Mr Weidmann described the expectation held by many market players of a first rate hike in the euro area in mid-2019 as "not wholly unrealistic".

Valuable aid to exit strategy

"Over the next few weeks and months, the Governing Council will have to address the issue of how to prepare a communication strategy for the normalisation process," Mr Weidmann stated. In the process, it would have to consider the extent to which further steps are communicated. On the one hand, he noted, the more comprehensive and specific the information is, the more precisely market expectations can be steered. On the other hand, very specific statements come with the risk of having to deviate from the communicated path on account of altered circumstances or new information, he pointed out. Mr Weidmann believes that the forward guidance will also "prove valuable when phasing out the non-standard monetary policy measures, without the ECB Governing Council having its hands tied for the future".