ECB: more policy accommodation needed
It will take time before we can read more into inflation data in the post-Covid world, but for now it seems clear that ‘domestic inflation’ is trending lower on most underlying measures. Euro area HICP headline inflation fell to -0.2% y-o-y in August from +0.4% in July. The decline was driven by core inflation, which fell to 0.4% y-o-y, an all-time low. We remain of the view that depressed demand should mean core inflation stays low, hovering around August’s level until the end of this year.
The most appropriate tool for the ECB to address the (pandemic) inflation gap remains asset purchases, starting with the Pandemic Emergency Purchase Programme (PEPP). We are sticking with our view that the ECB will ultimately increase the PEPP envelope again, most likely by EUR500bn in December. The hope will be that this is the last move the ECB has to make as fiscal policy takes over to support the recovery.
Other policy options include a further cut in the TLTRO-III minimum interest rate, to below -1%, as well as an extension in the maturity of the operations and/or in the period during which the minimum interest rate applies (beyond June 2021). We also continue to expect the ECB to increase the tiering multiplier from 6x to 8x, most likely in December.
Recent euro strength is also coming into focus. To be sure, the ECB will see a stronger euro as reflecting rising confidence in the single currency, but it is helping to depress core inflation and will likely remain an issue against the backdrop of the Fed’s structural shift to average inflation targeting. The ECB could provide stronger forward guidance, and a more explicit hint at a future rate cut to curb the euro’s rise in the short term.
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