At today’s meeting, the European Central Bank’s (ECB) Governing Council left its policy instruments largely unchanged, with one important exception: It judged, unanimously, that maintaining favourable financing conditions can be accomplished at a moderately lower pace of net asset purchases under the Pandemic Emergency Purchase Programme (PEPP) compared to the previous two quarters. That said, ECB President Christine Lagarde stressed that this change is to be viewed as a “recalibration” of the purchase facility for the next three months, but that “the lady is not tapering”, in an oblique reference to a phrase coined by Margaret Thatcher more than 40 years ago.
ECB staff also provided a new round of, once again, more positive macroeconomic projections. The GDP trajectory was revised up by 40 bps for 2021 in light of upside surprises in the Q2 print and a solid Q3 performance so far, but stayed largely unchanged for 2022 and 2023. The new forecast implies that the euro area will likely recuperate the pre-pandemic GDP level in Q4 this year, a quarter earlier than expected previously, whereas in a bullish scenario, this could already be achieved in the current quarter. The inflation path was also revised up, again, over the whole forecast period, but especially so for the current year for both temporary and persistent reasons. Headline inflation is expected to peak at 3.1% in Q4 this year, a full 50 bps higher than in the June projections, and the outlook for underlying inflation has also edged up gradually, with the 2023 estimate revised up by yet another 10 bps to 1.5%. The risks around the outlook continue to be balanced, but Lagarde noted that upside risks to inflation could arise if current supply bottlenecks feed into the autumn wage negotiations.
The better outturn for this year, in combination with a firming conviction on the outer years, enabled the ECB to reduce its purchase pace under the PEPP. While we think that this was a well-timed step at the current juncture given the light issuance calendar for Q4 and thereby limited upward pressure on interest rates, we wonder how that line of reasoning will change in the December meeting, ahead of a pick-up in issuance in early 2022. We believe this to be the key reason why Lagarde characterized today’s step as recalibrating rather than tapering—the latter cannot be easily reversed and the outlook for the Asset Purchase Progamme (APP) is unclear for now. Moreover, we note that Lagarde explicitly tied ensuring favourable financing conditions to the PEPP, implying that bond yields could drift steadily higher once the PEPP has ended even as the APP continues.
Lagarde also confirmed our expectation that the December meeting will play a pivotal role in the ECB’s monetary strategy. First, the macro projections will add 2024 forecasts, and we are likely to see the inflation trajectory edging up further. Second, the future of the PEPP itself as well as its interaction with the basic APP will have to be firmed up at that point. Finally, adding further Long-Term Refinancing Operations—or not—will also send an important signal about the ECB’s conviction level.
Notwithstanding the first market reaction and Lagarde’s effort to be non-committal on the outlook for PEPP, we believe that today’s meeting marked an important turning point. Rather than increasing the PEPP again in December, we can actually imagine a higher purchase pace under the APP at that point, pointing to the imminent end of the pandemic for monetary policy purposes. In the meantime, the ECB is back to watching wage negotiation dynamics over the autumn and associated upside risks for inflation—in Lagarde’s words, as an institution that is firmly data-dependent but not a data slave.