At today’s meeting, the European Central Bank’s (ECB) Governing Council (GC) left its policy instruments unchanged. In particular, the commitment to purchase assets under the Pandemic Emergency Purchase Programme (PEPP) at a “significantly higher pace” than in the first few months of the year was rolled over into Q3. The ECB also noted that PEPP purchases remain “flexible” to take into account market conditions.
ECB staff also provided a new round of macroeconomic projections. The GDP trajectory was revised up for 2021 and 2022 by 60 bps to 4.6% and 4.7%, respectively, but was left unchanged for 2023. The upward revisions to growth are roughly twice as large as the impact of the US fiscal expansion, which had not yet been factored into the March forecast. The inflation path was also revised up for this year and next, albeit largely on base effects and higher energy prices and therefore more so for headline than underlying measures. Headline inflation is indeed expected to peak at 2.6% in Q4 this year compared to 4Q20, but the outlook for underlying inflation in 2023 has been revised up by 10 bps in projections both from March and from today—a sign of progress for the ECB. Overall, the ECB is now a touch more optimistic than other international institutions that recently assessed growth and inflation in the eurozone. ECB President Christine Lagarde also noted that the risks around the economic outlook have improved since the March assessment and are now (broadly) balanced.
Our View
The ECB has punted its next monetary policy step successfully into the fall and we expect government bond yields to continue to rise gradually, providing support for the euro. No change in PEPP purchases is consistent with the largely unchanged economic outlook beyond the current rebound (i.e., in 2023). That said, we believe that there have been significant discussions around the outlook, risks to the outlook and also the pace of purchases, driven by countries where financing conditions have actually eased and where the inflation trajectory is substantially higher than in the eurozone as a whole (e.g., we expect German inflation to peak above 4% in Q4). Put differently, we believe that the ECB feels that there is still too much uncertainty to build long-range confidence, change the 2023 outlook and reduce the monetary accommodation, but the discussion is certainly growing livelier. Notwithstanding the divergences on specific issues, however, the GC still unanimously agreed to continue PEPP purchases at a significantly higher level.
President Lagarde also referred repeatedly to the “flexibility” under the PEPP when it comes to factoring in market conditions, and she explicitly mentioned seasonality. We interpret this as preparing the market for lower purchases over the summer when issuance drops and ECB buying typically follows suit, mainly in August. In other words, the PEPP guidance from the meeting might have supported the market against a concern of tapering, but in the end it might not be all that precise as the seasonality “excuse” to buy less kicks in soon.
On other issues, we note that while Lagarde was quite upbeat about the rebound, she did caution that inflationary factors are still viewed as temporary and country-specific. In this context, she mentioned supply bottlenecks explicitly, and clarified that she expects these to resolve soon. Lagarde also sidestepped questions around the future of PEPP and the Asset Purchase Programme (APP), seemingly teeing up the September meeting as a key turning point for the ECB. This is when we expect the ECB to announce higher growth forecasts for 2023, continued progress on underlying inflation, PEPP tapering and a number of other conclusions from the Strategy Review. The ECB might want to be a “steady hand” for now, but not for much longer.