Head of Macroeconomic Research
Summary: It was probably the most uneventful ECB July meeting since 2012 when Mario Draghi needed to act fast in order to contain the unfolding euro area crisis. It was clearly not necessary to interrupt your vacation to watch Christine Lagarde's presser. Basically, Christine Lagarde's main task today was to confirm that the ECB is ready to use the EUR1.35tr PEPP envelope in full. Job done. The ECB remains in full control of the yield curve so we expect a rather quiet summer market. However, further stimulus will be needed, at the earliest in September, when the Q3 staff projections will be released, in order to cope with the second economic wave of the virus characterized by business restructuring and permanent closures. Getting out from recession does not mean that we are back to normal. We still believe that the worst is yet to come in terms of job destruction and business bankruptcies.
Market expectations were very low regarding today’s meeting and presser. Despite a bleak economic outlook and risk of economic divergence within the euro area, there is no urgency for further stimulus in the short term. The ECB package consisting in the €1.35tr PEPP envelope, a high degree of flexibility in purchases, unlimited liquidity to the EZ banking sector via TLTROs and PELTROs and the creation of an Eurosystem repo facility has successfully managed to reduce financial fragmentation in the eurozone, and even conducted to a strong improvement in financial conditions over the past months. According to the ECB, measures taken from March to June this year will have a cumulative impact on real GDP growth estimated at 1.3% until 2022 and an impact on inflation estimated at 0.8% until 2022 (see here further details provided by ECB’s chief economist Philip Lane).
Ahead of the meeting, there were a lot of concerns regarding the possibility that the ECB might restrain from using the PEPP envelope in full. Concerns were fueled by ECB officials indicating it might not be needed and by the recent slowdown in PEPP purchases. Christine Lagarde removed any ambiguity regarding the use of the PEPP envelope in full (as of June, €335bn had been purchased on a total of €1.35tr) and, on top of it, she even opened the door to further stimulus if necessary. This is broadly a rather dovish message. With markets being comforted that the ECB remains in full control of the yield curve, we anticipate a very quiet summer market and further upside for the euro with a potential break of the pivotal resistance at 1.1495 for the currency pair EURUSD (see here John Hardy’s latest FX update).
We are onside with consensus in expecting the ECB will have no choice but to increase the total amount of PEPP, at the earliest in September when the Q3 staff projections will be released. It should give us a good indication of the path of the recovery and upcoming challenges. The recent improvement in data is a bit biased, as it mostly results from the base effect following the reopening of the euro area economy. As it is the case anywhere else in the world, there is no V-shaped recovery in sight for the eurozone, which means more fiscal and monetary support will be required. In terms of monetary policy, prolonged lower core inflation in coming months should provide sufficient room for maneuver for the ECB to expand the existing program. We estimate that the total envelope of PEPP in order to absorb all new public debt issuance due to the pandemic this year should be increased by €500bn, at €1.85tr. Such an extension, that can be potentially postponed to December, is necessary in order to cope with the second economic wave of the virus that will be characterized by business restructuring and permanent closures and that might increase economic instability and financial fragmentation in the eurozone. Contrary to some of our colleagues, we still don’t think that the ECB will discuss thoroughly any change in the tiering multiplier in the short or medium term. The topic of bank profitability might be raised only if we face a sharp increase in the ratio of non-performing loans in Q4 2020 – Q1 2021 on the back of a jump in business collapses.
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