At today’s meeting, the European Central Bank’s (ECB) Governing Council introduced a significant recalibration of its instruments, including a nine-month extension of the Pandemic Emergency Purchase Programme (PEPP), to March 2022, and a continuation of bank financing at ultra-low rates through 2021. The extension of the PEPP represents a €500 billion addition to the overall envelope, which is now €1.85 trillion, with reinvestments extended by 12 months (running at least through 2023). In addition, the central bank took a large number of other decisions that are all conducive to maintaining favourable financing conditions for households, corporates and official borrowers.
The ECB also extended the horizon of its macroeconomic projections into 2023. The GDP trajectory was revised down somewhat for this year and next given the restrictions related to the second wave of COVID-19 infections. Similar revisions were implemented for inflation, where the marking to market for 2020 resulted in a “disappointingly low” starting point and a rather slow convergence to target—2023 average inflation stands only at 1.4%. ECB President Christine Lagarde noted in this context that growth risks are still tilted to the downside but are less pronounced than they were previously due to progress on the vaccine front, whereas inflation is heavily impacted by temporary effects such as the German VAT cut and energy prices, but also by tepid demand and an appreciating currency.
The ECB’s decisions today are best observed in light of Lagarde’s speech at the ECB Forum in mid-November. The speech put stable and “favourable financing conditions” at the center of the ECB’s policymaking focus while there are no inflationary pressures to speak of. Although the additional targeted longer-term refinancing operations (TLTROs) and other related instruments are meant to provide a very advantageous financing framework to households and corporates, the PEPP extension also enables the ECB to support sovereign financing conditions around current levels for quite a while. Lagarde noted in the press conference that the ECB is slightly concerned about a marginal tightening of lending standards. We view this as indicative of the ECB’s new approach, which enables greater flexibility in intervention as soon as the final goal of favourable financing conditions is determined to be endangered.
Today’s press conference was essentially silent on policy interest rates, which is testimony to the fact that the deposit rate is not going to be cut any further at this time. On the other hand, the temporary extra-favourable conditions on TLTROs have been extended by another year, to June 2022, and function as the true marginal policy rate when providing steady financing to banks and the economy is the main intention. Indeed, in our judgement, the ECB today went a bit further on promoting bank financing rather than asset purchases, including by not rolling over the asset purchase programme (APP) top-up put in place last March and by stressing that the PEPP envelope must not be spent in full. The market perceived this as marginally hawkish, whereas in our perception, this aligns with the focus on financing conditions. It is clearly possible that the ECB needs to spend very little on additional purchases to guarantee the financing conditions it desires. In that sense, the ECB could end up in a situation similar to the Bank of Japan, albeit without the explicit adoption of yield curve control as this is not feasible in the eurozone.
We were also struck by how little time was dedicated to the currency—barely three months after ECB officials made a major point about its appreciation at their last meeting and elsewhere. In many ways, there is very little that the ECB can and will do about it as long as it doesn’t interfere with financing conditions, and today’s press conference drove that point home. The market reacted as expected—the euro appreciated, and fixed-income sold off somewhat from pre-meeting levels. Going forward, we expect the euro’s gentle appreciation to continue and the volatility of sovereign and corporate bonds to fall.
Lagarde stressed of course that the ECB stands ready to adjust its instruments as needed but the goal today was to avoid precisely that for an extended period of time, providing certainty and predictability about “favourable financing conditions” deep into 2021. Plus ça change, plus c'est la même chose.