Along with an expanded pandemic support programme, we could see some innovations from the ECB next week
Nadia Gharbi, Europe Economist & Frederik Ducrozet, Strategist
Notwithstanding encouraging news at the EU level and the recent rebound in market sentiment, several ECB officials have signalled their intention to use the Governing Council meeting next week to add to the current monetary policy stimulus in light of the continued deterioration of the economic outlook.
Banque de France Governor François Villeroy de Galhau went on record to call for the ECB to act “rapidly and powerfully”, seeing a “flexible” Pandemic Emergency Purchase Programme (PEPP) as the “preferred” instrument for dealing with the consequences of the crisis caused by covid-19.
We expect the Pandemic Emergency Purchase Programme (PEPP) to be increased by EUR500bn (to EUR1,250bn) at next week’s policy meeting, and extended through September 2021, with the ECB standing ready to do even more. In addition, the composition of PEPP purchases could be adjusted, and new measures targeted at the banking sector are also possible.
Importantly, in addition to expanding the PEPP, Villeroy’s comments suggest that there is room for the ECB to surprise by introducing some policy innovations. We see four important decisions that the ECB could make, none of which we think are fully priced in. The bank could:
Start reinvesting PEPP securities;
Increase the share of supranational debt securities (from 10% of public bond purchases currently;.
Include fallen angels in asset purchase programmes; and/or
Increase the tiering multiplier (from 6x to 8x currently).
Euro area Q1 GDP fell by 3.8% q-o-q in Q1, the worst GDP figure on record. Q2 will likely look worse since most economies remained in strict lockdown throughout April, with economic activity resuming only very gradually in May. The ECB is likely to emphasize the risk of diverging trends within the currency union, but probably also welcome the ambitious European Commission recovery fund proposal unveiled yesterday.
In early May, the ECB presented different growth scenarios, with GDP expected to contract by 5-12% this year before growing by 4-6% in 2021. Christine Lagarde’s comments suggest that the ECB will adopt a baseline forecast for euro area growth somewhere between its medium and severe scenarios—in other words, around -9% in 2020, 5% in 2021 and 3% in 2022, with headline inflation at 0.3%, 1.0%, 1.5%, respectively.