COVID | Europe | Monetary Policy & Inflation
Thursday’s ECB governing council meeting comes amid a shifting European landscape. Since the last policy meeting in April, the ECB now faces the potential end to Bundesbank participation in its asset purchase programme and, on a more positive note, a sizeable European recovery fund that could alleviate some of the burden on monetary stimulus. Yet with the Coronavirus crisis still requiring near-term response, we expect the ECB to press ahead with an increase in the size/composition of its pandemic emergency purchase programme (PEPP) or a clear indication that it will do so soon.
Updated Forecasts Provide a Rationale for Expanding PEPP
At the last governing council meeting in April, the ECB statement reiterated its willingness to expand the size and duration of the PEPP ‘by as much as necessary and for as long as needed’. We had argued against expectations for any change at the April meeting on the basis of sizeable room left within the €750bn envelope leaving a commitment to future adjustment as all that was necessary. With purchases now at €235bn, on a pace of around €30bn per week, the current limit will be expended by end September. The ECB could therefore afford to wait to step up PEPP; but with new macroeconomic forecasts at Thursday’s meeting pointing to a significantly worse outlook for growth and inflation, the Governing Council can easily justify programme expansion.
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Thursday’s ECB governing council meeting comes amid a shifting European landscape. Since the last policy meeting in April, the ECB now faces the potential end to Bundesbank participation in its asset purchase programme and, on a more positive note, a sizeable European recovery fund that could alleviate some of the burden on monetary stimulus. Yet with the Coronavirus crisis still requiring near-term response, we expect the ECB to press ahead with an increase in the size/composition of its pandemic emergency purchase programme (PEPP) or a clear indication that it will do so soon.
Updated Forecasts Provide a Rationale for Expanding PEPP
At the last governing council meeting in April, the ECB statement reiterated its willingness to expand the size and duration of the PEPP ‘by as much as necessary and for as long as needed’. We had argued against expectations for any change at the April meeting on the basis of sizeable room left within the €750bn envelope leaving a commitment to future adjustment as all that was necessary. With purchases now at €235bn, on a pace of around €30bn per week, the current limit will be expended by end September. The ECB could therefore afford to wait to step up PEPP; but with new macroeconomic forecasts at Thursday’s meeting pointing to a significantly worse outlook for growth and inflation, the Governing Council can easily justify programme expansion.
Increasing the size (to €1trn or more), lengthening the timeframe to 2021 and adjusting the eligibility criteria to include purchases of junk bonds (specifically those who tip over from investment grade) are the most likely options. Fallen angels are now temporarily included in collateral for liquidity operations anyway, and, while Christine Lagarde said there was no discussion on changing the eligibility criteria at the last meeting, we expect at a minimum this will have been discussed on Thursday.
Headline inflation has fallen sharply during recent months and the updated Staff projections are set to shift even further below target. Moreover, several Council members have recently stated a near-term preference to adjust policy. Executive Board member Schnabel pointed to projected weakness in the inflation outlook as a reason to act on policy, while the Banque de France governor stated a preference to increase PEPP.
On GDP growth, the updated projection is likely to be somewhere between the 8% contraction expected in the ECB’s earlier medium scenario and the 12% contraction in a severe contraction. But what matters more is the ECB’s view on the expected recovery. While forecasting is undoubtedly difficult during the COVID crisis, any indication of lower potential growth and a loss in output not made up by the end of the projection period would be very negative.
German CC Ruling Unlikely to Stand in the Way
We do not expect the 5th May German Constitutional Court ruling questioning the proportionality of the ECB’s public sector purchase programme to deter the Governing Council from acting. ECB chief economist Philip Lane recently reiterated the bank’s official line, saying, ‘we took note and remain undeterred in our pursuit of monetary policy’. The Bundesbank has three months to respond to the ruling, and we expect Lagarde to remain fairly tight-lipped on the topic during the Q&A other than saying the ECB has always acted within its mandate as confirmed by the earlier ECJ ruling and reminding once again that the ECB has various tools at its disposal to adjust monetary policy.
Further monetary accommodation through other tools seems unlikely at this meeting. We expect no change in interest rates and, with the favourable changes to the TLTRO III terms at the last meeting (lowering the rate by 25bps) and the introduction of pandemic emergency longer-term refinancing operations (PELTROs), there is no obvious need for adjustment. The €20bn/month (plus additional €120bn by year end) under the pre-existing asset purchase programme is also likely to remain unchanged.
Recovery Fund: A Medium-term Positive
Lagarde will likely repeat her earlier support for the proposed €750bn EU Recovery Fund and use the press conference as an opportunity to yet again stress the potential power of coordinated fiscal support. While the details of the plan remain unknown (and it may not garner the required support from all states), the mechanism to disburse loans/grants via the next seven-year EU budget cycle starting in 2021 leaves any increased spending impacting the outlook only from next year.
(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.)