Welcome to Thoughts on the market. I am Reza Mocadam, Morgan Stanley's chief economic advisor.

Along with my colleagues, we bring you a variety of market perspectives.

Today I'll be talking about what to expect from the

European Central Bank in 2021. It's Tuesday, January 12 at 2 PM in London.

European policy makers, often paralyzed by divisions, finished

2020 on a high note. They finalized the 750 billion European Recovery Fund, agreed to ambitious climate targets, and via the European

Central Bank announced new measures to ensure easy financing conditions in the coming year.

Together with a reliable vaccine pipeline,

all this makes for a strong outlook for 2021.

So does a robust recovery spell the end of ECB action?

Only one inconvenient fact stands in a way, the ECB's chronic inability to deliver on its inflation

target of close to but under 2%.

Unlike in the US, inflation in the euro area has been closer to 1%

than to 2% for most of the last 8 years and markets are currently expecting that to remain

the case for the next decade. A sinking inflation anchor is a grave problem for any central bank. Lower bond deals don't help

if expected inflation falls at the same time, leaving expected real rates unchanged. The ECB could soon find its effectiveness compromised

and bracketed by the markets with the Bank of Japan as an institution perpetually at war with the risk of deflation.

The complication for the ECB is that an influential hawkish minority at the ECB Governing Council is prepared to shrug off the low inflation problem,

declare victory and bring stimulus to an early end. The problem with accepting lower inflation, aside from raising real debt burdens, is that it doesn't leave much room for price and wage adjustment between different

needs and vulnerabilities. And with the Fed moving in the opposite direction,

it risks casting the ECB as a congenitally hawkish central bank. This could strengthen the euro and push

down inflation even more. My sense is that the doves, not the hawks at the ECB, will ultimately prevail, especially given the risk of long-term economic

...