At today’s meeting, the European Central Bank’s (ECB) Governing Council (GC) surprised markets by including an explicit commitment to a “significantly higher pace” of purchases under the Pandemic Emergency Purchase Programme (PEPP) over the next quarter. This decision was taken unanimously. All other policy levers remained unchanged.
ECB staff also concluded a new round of macroeconomic projections for the eurozone. While the GDP trajectory was left largely unchanged, the inflation path was revised up mainly for this year on the back of a number of technical factors. ECB President Christine Lagarde also mentioned that inflation expectations—especially market-based measures—have continued to improve, but that this did not find its way into a higher forecast for 2023 (unchanged at 1.4%). In this context, Lagarde pointed out that economic risks are more balanced than they were at the last projection round in December 2020. Lagarde also specified that the current projections do not yet include expected spill-over effects from the recently approved US stimulus program, which should provide upside potential at the next forecast round in June.
Our View
With its commitment to increasing the purchase pace significantly, the ECB is following other central banks—notably the Reserve Bank of Australia—that have recently stepped up their resistance to accentuated volatility in government bond yields. This formal decision elevates the pace of purchases to the level of an explicit policy variable, thereby conveying the importance of this step but also reducing the ECB staff’s discretion in this matter, as it is now a decision to be taken by the GC. Judging from Lagarde’s press conference, the level of PEPP purchases will be more formally reviewed on a quarterly basis in the context of the macroeconomic assessment of financing conditions. One unintended consequence of this change is a new market risk in the form of a “PEPP tapering” announcement emerging on a quarterly basis.
Lagarde spent a significant amount of time in the press conference explaining the ECB’s “holistic” and “multifaceted” assessment of financing conditions, with the key takeaway being that the ECB considers premature tightening of those conditions as undesirable. In Lagarde’s mind, there is no precise number for the correct amount of PEPP purchases over the next quarter as it depends on how far the financing conditions are off course. In other words, today was really a re-launch of the PEPP as a flexible and potentially aggressive instrument rather than another layer of steady purchases akin to the Asset Purchase Program (APP).
Today’s decision came as a dovish surprise for the market and ignited a significant rally in peripheral bond markets, with the spread of Italian 10-year government yields converging close to recent lows. While Lagarde did not specify a historic reference point that would satisfy the mantra of favourable financing conditions, it stands to reason that the post-announcement impact of higher purchases went a long way to satisfy the ECB.