Europe Preview: EU Summit To Set Summer Mood

The next few days could mark an important turning point for Europe. Agreement on a €750bn EU recovery fund, even if only partial, would be a significant step forward for fiscal coordination and send an important signal on solidarity. A reduced burden on monetary stimulus will also be welcome. Any recovery fund is unlikely to materially change the path of economic recovery over the coming quarters, but, without it, market stress and fragmentation within the transmission of monetary policy could well return.

ECB: Taking Stock

Thursday’s ECB meeting is unlikely to bring new policy announcements. The ECB delivered a larger-than-expected €600bn increase in the size of its pandemic emergency purchase programme (PEPP) at the last meeting on 4 June and extended the programme through June next year. Weekly purchases are averaging around €26bn, to stand at €383bn out of a €1.35tn envelope. Earlier announcements on pandemic emergency longer-term refinancing operations (PELTROs), more favourable terms on the existing TLTRO-IIIs, and an easing of collateral requirements also add to the loosening in monetary policy over recent months.

ECB President Christine Lagarde appeared to confirm in a recent interview that this week’s meeting would be an opportunity to take stock: ‘We have done so much that we have quite a bit of time to assess [the incoming economic data] carefully.’ Q2 GDP data due at the end of this month will be important for assessing whether the ECB’s June forecast of GDP growth at -8.7% this year is broadly on track. But more high-frequency data such as mobility and PMIs are more meaningful to gauge the Q3 bounce. Latest releases here point to a fairly substantial rebound in activity; but with COVID still very much a threat and the holiday season just beginning, the potential for new outbreaks and localised lockdowns is significant.

Euro-area inflation remains positive, with the flash estimate for June increasing versus a month earlier (0.3% YoY in June versus 0.1% in May) as energy prices climbed MoM. But core inflation has continued to drift lower and will likely continue to do so as demand remains weak. Lagarde will probably present the ECB’s very accommodative stance as necessary to ensure inflation returns close to target and the economic recovery gathers pace. But she will also use the press conference as an opportunity to stress the importance of the fiscal response in Europe’s recovery and, while not ruling out more monetary stimulus if needed, reminding that a lot has been done and that EU governments must now step up in a coordinated way.

EU Summit: Progression, Not Completion, Needed on the Recovery Fund

The in-person summit in Brussels on Friday will end weeks of diplomacy across Europe as leaders try to achieve unanimity on the proposed €750bn (5.4% of 2019 GDP) Next Generation EU plan. German Chancellor Angela Merkel said recently, ‘It is important that what we now have as a recovery fund is massive, is something special and is not reduced to dwarf size’. Merkel and other allies have stressed the importance of an agreement for the whole of Europe, but it remains unclear just how far the Netherlands, Austria, Denmark and Sweden (the frugal four) are willing to compromise on earlier demands linking funding to structural reforms.

Details on timing, allocations, composition (loans versus grants) and conditionality will all be crucial to reach an agreement, and it is unclear whether all this can be agreed this week. Dutch PM Mark Rutte has spoken more favourably about the plan in recent weeks but has yet to commit to any specifics. The latest compromise sees the €750bn recovery fund (financed via EC bond issuance) remaining intact but the EU’s €1.1tn seven-year budget cut to €1.07tn from €1.1tn. A lump sum rebate for Germany and the frugal four may also be on the cards according to European Council President Charles Michel.

A second summit may be needed later in the summer to finalise details (and indeed Lagarde said recently that she does not think the agreement will come at this summit), but what’s important this week is 1) no reduction in the headline €750bn size, 2) positive comments from Rutte that an agreement is close and 3) broad agreement on any conditionality.

As funding is set to be disbursed over the period 2021-24 it will not directly impact the near-term recovery of the Euro-area. It will, however, impact it indirectly because any failure to reach an agreement would be seen very quickly in spreads and financial conditions.

Caroline Grady is a Senior Researcher at Macro Hive. Formerly, she was a Senior EM Economist at Deutsche Bank and a Leader Writer at the Financial Times.

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