Europe | Monetary Policy & Inflation
The ECB has made it explicit that additional stimulus will be announced at its Thursday Governing Council meeting. Market expectations are for an increase in PEPP of around €500bn and an extension of the favourable interest rate on TLTROs. President Lagarde is unlikely to disappoint, and we see a risk of more, not less.
PEPP and TLTRO Expansion Expected
Markets are in risk-on mode as vaccine rollout news prompts optimism for a global rebound next year. But the ECB faces the more immediate reality of further downgrades to its GDP growth and inflation forecasts. The surge in COVID across Europe in recent months has meant activity and mobility dropped once again, and the bounce back in Q3 GDP was short-lived. Q4 GDP projections will be sharply lowered versus the last forecasting round. And while some assumptions over vaccine rollout may be incorporated into the projections, this will not be in the immediate quarters. As such, the ECB’s 2021 GDP growth projections will be lowered from the 5% projected in September.
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The ECB has made it explicit that additional stimulus will be announced at its Thursday Governing Council meeting. Market expectations are for an increase in PEPP of around €500bn and an extension of the favourable interest rate on TLTROs. President Lagarde is unlikely to disappoint, and we see a risk of more, not less.
PEPP and TLTRO Expansion Expected
Markets are in risk-on mode as vaccine rollout news prompts optimism for a global rebound next year. But the ECB faces the more immediate reality of further downgrades to its GDP growth and inflation forecasts. The surge in COVID across Europe in recent months has meant activity and mobility dropped once again, and the bounce back in Q3 GDP was short-lived. Q4 GDP projections will be sharply lowered versus the last forecasting round. And while some assumptions over vaccine rollout may be incorporated into the projections, this will not be in the immediate quarters. As such, the ECB’s 2021 GDP growth projections will be lowered from the 5% projected in September.
Inflation forecasts are also set to be revised lower. CPI has been negative in recent months and below ECB forecasts, leaving a lower starting point for the December projections. And combined with weaker economic activity and further euro strength, the 1.0% and 1.3% in 2021 and 2022 respectively will shift lower. 2023 forecasts are expected to see inflation remain very subdued.
With the ECB pre-committing to ‘recalibrate its instruments’ in December, the only questions are how much and what form they will take. The pandemic emergency purchase programme (PEPP) and TLTROs have been widely discussed as the likely tools.
On PEPP, the current €1.35trn is expected to increase to around €1.85trn and the current June 2021 end date to be pushed out by around six months. Current holdings are €696.575bn, with monthly net purchases of just above €60bn. But despite ample space remaining, comments – that the ‘duration of our main tools should be linked to the duration of the pandemic crisis phase, and this would refer both to the asset purchases and to the TLTROs’ – point to a clear intention to extend the timeframe.
Changes to the TLTRO-III parameters could come in various forms. Longer maturity loans, increasing the number of TLTRO operations and extending the timeframe of reduced rates on TLTROs (currently 50bps below the depo rate through June 2021) are all options. A six-to-12-month extension of the favourable rate is the most widely discussed option, plus the addition of a few more operations.
Rate Cut and Higher Tiering Multiplier Are Other Options
Only one bank is calling for a cut to the deposit rate according to the Bloomberg survey. No major central bank has opted to take rates deeper into negative territory through the COVID crisis, leaving such a move a bold call. But with the ECB viewing its tools as complementary, there could be some case for this to be used. If accompanied by an increase to the tiering multiplier, this would offset further negative impact on banks.
President Lagarde will presumably stress yet again that, while monetary support has been stepped up, fiscal policy must come to the fore. The EU summit will be ongoing at the time of the ECB meeting. And EU leaders are unlikely to let Hungary and Poland block agreement on the next EU budget / EU Recovery Fund.
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.)