Economics & Growth | Europe | Monetary Policy & Inflation
Europe’s economy is on the cusp of a double-dip recession. A worsening COVID situation and a tightening of restrictions means the bloc could record another quarterly contraction through Q1 2021, after what is widely expected to be a negative reading for Q4. But that will be insufficient to prompt any ECB action on Thursday. Monetary policy was ‘recalibrated’ in December, and further loosening is off the radar for now.
Politics rather than economics has dominated European news flow in recent days. Italy’s government is near collapse after Matteo Renzi’s party withdrew from the coalition; Germany’s CDU have elected a new leader, Armin Laschet; and the Dutch government resigned, leaving the Netherlands with a caretaker government ahead of elections in March. Political noise in Europe, combined with the expectation for significant US fiscal stimulus under a Democrat House and Senate, has seen the dollar gain ground. Versus the highs of 1.23 at the start of the year, the euro has pulled back close to 1.21.
As fiscal easing, rather than additional monetary loosening, is the main policy tool this year, political risks in Europe could significantly impact the recovery. While the ECB will avoid commenting directly on the ongoing political events, the noise has the potential to impact spreads and the transmission of monetary policy. But in contrast to April/May last year, when spreads on Italian BTPs blew out to around 250bps, the widening this time is modest.
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Europe’s economy is on the cusp of a double-dip recession. A worsening COVID situation and a tightening of restrictions means the bloc could record another quarterly contraction through Q1 2021, after what is widely expected to be a negative reading for Q4. But that will be insufficient to prompt any ECB action on Thursday. Monetary policy was ‘recalibrated’ in December, and further loosening is off the radar for now.
Politics rather than economics has dominated European news flow in recent days. Italy’s government is near collapse after Matteo Renzi’s party withdrew from the coalition; Germany’s CDU have elected a new leader, Armin Laschet; and the Dutch government resigned, leaving the Netherlands with a caretaker government ahead of elections in March. Political noise in Europe, combined with the expectation for significant US fiscal stimulus under a Democrat House and Senate, has seen the dollar gain ground. Versus the highs of 1.23 at the start of the year, the euro has pulled back close to 1.21.
As fiscal easing, rather than additional monetary loosening, is the main policy tool this year, political risks in Europe could significantly impact the recovery. While the ECB will avoid commenting directly on the ongoing political events, the noise has the potential to impact spreads and the transmission of monetary policy. But in contrast to April/May last year, when spreads on Italian BTPs blew out to around 250bps, the widening this time is modest.
December Recalibration Leaves Significant Space Left Under Current Parameters
The ECB can therefore concentrate on monetary policy at Thursday’s meeting. And given the size of the recalibration last month, there is no urgency for any further changes. At the December meeting, the ECB increased the size of its Pandemic Emergency Purchase Programme (PEPP) by €500bn, to a total of €1.85bn. It extended the purchase period to March 2022, added additional TLTROs, and extended the timeframe for the favourable financing rate on TLTROs by a year to mid-2022.
With just €780.7bn in PEPP purchases through 15 January, the ECB has significant scope left under the current parameters. And with updated forecasts not due until March, there is no reason to expect any changes to monetary policy.
Downside Risks Rising, But Remain Reasonably Contained Versus Baseline
President Lagarde will nevertheless stress the increased downside risks, and significant uncertainty, over the outlook. Vaccine rollout is slow on the Continent, and COVID numbers in Germany and France continue to rise sharply (albeit below the peak in terms of new daily cases). The ECB has plenty of scope to accelerate PEPP purchases if needed, and, as always, there will be a commitment to use all monetary policy instruments if required. But with Brexit risks now largely out of the way and the prospect of a European Q2 recovery still broadly on track, we do not expect Lagarde to sound too downbeat. Also worth noting is that the ECB’s December forecasts are fairly similar to the latest Bloomberg consensus on inflation, and for 2021 growth the ECB is below consensus.
Thursday’s focus will therefore be on what the ECB has to say, rather than what they do. Any comments on the euro, the recovery and the impact of a potential Fed taper will all receive attention.
Caroline Grady is Head of Emerging Markets Research at Macro Hive. Formerly, she was a Senior EM Economist at Deutsche Bank and a Leader Writer at the Financial Times.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)