The urgency of doing nothing
Next week, the main decision the European Central Bank’s (ECB) Governing Council will have to take will be about the pace of its Pandemic Emergency Purchase Programme (PEPP) purchases in Q3. While recent macro data have been very encouraging and bond yields have stabilised over the last couple of weeks, ECB speakers have clearly leaned on the dovish side lately, including ECB president Christine Lagarde herself.
In terms of wording, our guess is that the ECB will commit to maintaining a (possibly “moderately” or “somewhat”) “higher” pace of PEPP purchases in Q3, but not “significantly higher”—effectively signalling a modest slowdown from Q2 that would still leave monthly purchases above their historical average. The ECB will likely highlight that its purchases will remain flexible and dependent on market conditions and “seasonal factors”, as ECB executive board member Isabel Schnabel said in a recent interview. This would be consistent with lower PEPP purchases on average in Q3—say around EUR65-70 bn per month compared with EUR80 bn in Q2.
Any actual decision about the tapering of the PEPP could be postponed until September and announced in parallel with the outcome of the ECB’s strategy review. We expect the PEPP to end by the summer 2022, with asset purchases gradually phased out in the first half of next year.
From a more fundamental perspective, the focus next week will be on ECB staff projections, especially on two important points. First, the spillovers from the US fiscal stimulus are set to be factored more explicitly into the ECB’s projections for the first time. This will provide a significant additional tailwind to euro area growth in the near term. While it is unclear to what extent domestic stimulus (including, of course, the implementation of the Next Generation EU recovery fund) will be taken into account, there is no doubt that the outlook for the euro area policy mix will have improved – the question is, by how much.
Second, the changes to financial variables used as inputs in the ECB staff projections will be negative on balance. The 14% rise in oil prices since the March meeting will push headline inflation higher but will weigh on prospects for consumption. Meanwhile, the circa 20 bp rise in bond yields and the 0.7% appreciation in the trade-weighted euro since March will weigh on growth and core inflation projections.
Given the subdued medium-term outlook for euro area inflation, we continue to expect the ECB’s (non-PEPP) Asset Purchase Programme (APP) to be increased in size, from EUR20 bn to EUR30 bn per month, with some of the flexible features of the PEPP transferred to the APP in 2022.