This week with the ECB meeting investors will be watching the European Central Bank’s interest rates, second quarter Eurozone GDP and polls due to the German elections. We have received the first insights on the outcomes of this meeting.
Paul Diggle, Deputy Chief Economist, Aberdeen Standard Investments
This ECB meeting will be an important one for investors because there is a good chance the Governing Council announces a reduction in the run rate of PEPP asset purchases. A variety of ECB policymakers, from the usual hawks like Jens Weidmann but also including Phillip Lane the chief economist, have been dropping hints that it’s time to dial back a little the pandemic-era emergency policy support. Of course, this would come around the same time that the US Fed has been discussing tapering asset purchases, and a number of other major central banks are moving in a less accommodative direction. But even if the ECB announced a PEPP reduction, it will still keep the old APP QE programme running for a long time to come, while there is little end in sight for negative interest rates in the Eurozone. So over time the ECB could look like a dovish standout amid the global move towards slightly tighter monetary policy, opening up some interesting investment implications.
Tomasz Wieladek, International Economist at T. Rowe Price
What do you expect the ECB to do when it meets next week?
Short Answer: The ECB could announce a reduction in PEPP purchase pace next week (more than 60% chance). However, the decision on expanding the PEPP envelope will be made in December. My view continues to be that the ECB will either expand the PEPP due to lingering downside Covid risks or significantly raise the APP to help reach the new inflation target. Policy makers and ECB accounts of the July meeting suggested that the ECB will decouple forward guidance on QE from forward guidance on interest rates (I.e. allowing for QE to end before interest rates are raised). It is plausible that we will hear more about this decoupling at the September meeting. Such a decoupling would imply an end to QE before raising rates. I am not sure that this is priced.
Long Answer:
The ECB will announce its policy decision and publish forecasts on Sep 9th. A number of speeches in recent days have changed my view on what may happen at this meeting. The Growth and inflation forecasts will be revised up for2021, though the ECB will continue to look through inflation. In August the Euro depreciated and Bund yields hovered around the -50bps level for a longtime. As a result financial conditions eased significantly since the last ECB meeting. In a speech last week, Chief Economist Phillip Lane indicated that the ECB focuses on financing conditions (I.e. the outcome variable), not a specific PEPP pace. Yesterday French CB governor Villeroy de Galhau hinted at a possible slowdown in PEPP purchases in Q4. Austrian Governor Holzman, a hawk, also pushed this idea this morning. Given recent policy maker communications, there is a greater than 60% chance of announcing a reduced PEPP purchase pace next week. This is already partially in the price.
The accounts of ECB’s July meeting suggested that the ECB will decouple forward guidance on interest rates from forward guidance on QE. A number of GC members who disagreed with forward guidance, including Belgian Central Bank governor Pierre Wunsch, explicitly said that they voted against forward guidance because they did not want to see a decade of QE only because inflation is below 2%. The current guidance on the APP says that it will end shortly before it starts raising the key ECB interest rates. From the accounts of the July Governing Council meetings, it seems that several members were concerned about the implication that forward guidance on rates has for QE. They were concerned that the current wording implied that QE would last as long as low interest rates, which it does. They agreed to discuss forward guidance on QE at a future meeting. So September could see a change in the QE wording. I am sure if, despite discussing this in the account, this is priced?
What about my view after September? Chief Economist Lane told us that he sees the PEPP program as downside risk insurance. This means that the program will going so long downside risks from the Pandemic persists. This doesn’t need to be a big Euro Area Covid outbreak, but could be a covid-led slowdown in the US or China spilling over into the Euro Area. Because it is likely that these downside risks will remain significant as we move into the winter time, My view remains that the ECB will likely extend the size of the PEPP at the December meeting. If that doesn’t happen, they will expand the APP at that meeting. A Cliff edge in asset purchases is unlikely.
Konstantin Veit, Portfolio Manager at PIMCO
The ECB meets on Thursday and we expect no material changes to monetary policy.
New staff macroeconomic projections and the current March 2022 end date of the pandemic emergency purchase programme (PEPP) offer an opportunity for a more holistic evaluation of the post pandemic policy reaction function in September, incorporating the findings of the freshly concluded strategy review deliberations.
In our view, the strategy review results institutionalize the recent ECB pivot from intensity to duration of monetary policy support, which is reflected in a strong focus on persistence of monetary policy action close to the lower bound on interest rates. We expect the ECB to maintain the practice of regular joint assessments of financing conditions and inflation outlook to derive asset purchase quantities, and to emphasize existing APP flexibilities, particularly in relation to an impaired transmission mechanism which should dispel concerns about ability and willingness to deviate from the capital key as needed.
Erick Muller, Head of Product and Investment Strategy Muzinich & Co.
In the last two weeks before the embargo, several senior members of the European Central Bank (ECB) Governing Council expressed the view that the forward guidance on the Pandemic Emergency Purchase Programme (PEPP) should be revisited soon. Actual data for 2Q GDP shows a better outcome than expected and inflation numbers also surprised to the upside.
While we cannot be surprised by the fact that the PEPP rhythm has to incorporate the probable improvement of ECB staff forecasts at September’s meeting, one can be surprised by the very open and strong positions expressed by many Governors and the capitulation of the “doves”, with a total absence of push back to this accumulation of statements on lowering the PEPP.
The ECB’s Philip Lane spoke about “local adjustment” in his most recent interview, and it seems that there is more than just a marginal adjustment at stake, with a possible decision of a framework to end emergency programmes in the next couple of quarters.
We do expect a decline in the PEPP from EUR 80 bn per month to EUR 60 bn, with an unchanged Asset Purchase Programme (APP) at EUR 20 bn per month to be announced at the meeting this week. This would recalibrate the PEPP monthly purchase to close to what was the average of 1Q 2021. As the net supply of Euro government bonds is expected to decline in 4Q 2021 and given the price adjustments in Euro government bonds already witnessed over the past two weeks, we do not think the confirmation of such a PEPP adjustment would in isolation push Euro government bond yields much higher.
However, other factors can push government bond yields materially higher. Has the perception of inflation changed so much within the Governing Council to meaningfully remove the accommodative monetary stance? What matters most is any indication around the end of the PEPP, i.e., if March 2022 is confirmed as the last month for PEPP purchases, and if the envelope will be fully used by then. Will the APP be recalibrated to avoid an asset purchase “cliff” in 2Q22? Will eurozone governments reduce their budget deficits enough to avoid the risk of a mismatch between ECB support and Euro government financing needs?
In our view, we are entering into a period where we expect government bond volatility to increase. Corporate credit markets are benefiting from strong and improving fundamentals with persistent demand from investors. The low value proposition in government bonds is quite a positive argument in favour of credit markets as long as the economic and earnings cycle is robust. While the PEPP was very much geared towards the purchase of government bonds, what comes next with the APP will be important news for Euro credit markets, particularly investment grade.
Annalisa Piazza, Fixed-Income Research Analyst, MFS Investment Management
The ECB Governing Council meeting on Thursday is expected to be ‘lively’ with market participants mainly focused on two major decisions that could lead to some volatility in the EGBs space. First, we expect the ECB to make an announcement on PEPP for Q4, re-calibrating the current pace to make sure it is consistent with the macro picture and current state of financing conditions. Secondly, the updated ECB projections for growth and inflation will shed more light on how policy makers are looking at medium term risks (especially for inflation) after the recent spike in prices and indications that global demand might have peaked (with the spreading of the Delta variant and moderation in China).
As for the future of PEPP, we expect the ECB to announce some modest adjustment for Q4 (EUR 60-65bn from the ongoing EUR 80bn pm). Despite the slower pace of purchase, we suspect Lagarde will be keen on maintaining a dovish bias, highlighting that the recalibration doesn’t represent a tapering move but simply a re-alignment to economic developments and recent trends in (extremely accommodative) financing conditions.
Looking at the updated ECB projections, we anticipate a slight upward revision for both GDP and inflation for 2021 and – given the positive carry-over effects – also for 2022. Inflation has surprised to the upside in recent months and August HICP reached 3%, well above the ECB inflation target.
We expect the ECB to acknowledge the upward move but maintain the narrative about temporary factors correcting from early 2022 and subdued wage growth posing limited risks for inflation in the medium term. That said, we rule out that the 2023 HICP and core inflation numbers will be revised considerable higher, testament that the ECB is unwilling to move away from its dovish bias anytime soon. All in all, we expect the ECB to maintain its broadly balance risk assessment for both growth and inflation.
From a market perspective, the still dovish bias at the next ECB meeting is likely to maintain the short end of the EGBs curves anchored at current levels. For now, we suspect the ECB (as other Central Banks such as the Fed) will prefer to maintain an extremely accommodative stance with regards to the path of possible rate hikes. Further discussion on the future of QE (i.e. how much flexibility will be given to the APP programme) are expected to happen later.
Martin Wolburg, Senior Economist and Elisa Belgacen, Senior Credit Strategist, Generali Investments
The post-lockdown recovery is proceeding. Strong activity in Q2/2021 (GDP 2.0% qoq) pushed euro area output up to just 3% below the pre-Covid-19 level. This was stronger than expected. The average reading of the PMIs for July and August (composite PMI at 60.2/59.5 vs. Q2 av. of 56.8) signals that activity even accelerates in Q3.
Clouded economic outlook
That said, there are clear signs for decelerating activity at the horizon. First, the pandemic situation is worsening again. The spreading of the more infectious delta variant will push new Covid-19 cases further up, a burden for consumer sentiment (that started to deteriorate in July) and purchasing activity (see top chart). If the vaccination progress was to be considered insufficient even a tightening of stringency measures could take place.
Second, semiconductor shortages persist. Delivery times in manufacturing are still close to the Q2 highs. This will continue to drag on industrial production. Likewise, unfavourable weather events and strikes in some economies will dampen activity.
Therefore, it is not surprising that forward-looking components in key sentiment indicators worsened (see midchart) heralding decelerating activity. Hard data for Q3 are not yet available but we expect them to paint a less rosy picture than the PMIs. All in all, we look only for a slightly accelerating activity in Q3 (to 2.2% qoq) and stronger deceleration thereafter. In spite of strong Q2 GDP reading we adjust our 2021 growth forecast up to only 4.9% (from 4.6%) and leave our 2022 number of 4.5% unchanged.
Another dovish message from the ECB in September
The forthcoming policy meeting on September 9 will likely reaffirm the ECB’s dovish wait-and-see stance. The outlook update will result in higher growth and inflation numbers. The expected increase of inflation will not have policy ramifications as it will still be considered transitory and not alter the ECB’s forward guidance on rates. Moreover, in a recent interview of Chief Economist Lane suggests that PEPP tapering might once again be postponed. This is in line with our view. As the PEPP is clearly tied to the pandemic, its worsening could even increase the risk that the PEPP might be extended beyond March 2022. In any case, the recent data flow plays in the hands of the doves and this should also be reflected in President Lagarde’s comments.
Credit
The ECB is the largest player in the corporate credit market in Europe, holding close to 25 of the eligible space However, we expect the discussion on the tapering to leave corporate bonds mostly insensitive as only the ECB’s emergency program, the PEPP, will be halted Indeed, the amount of credit within this program is very low The ECB is mostly supporting the private bond market through its APP which will run shortly before the ECB starts to raise rates Although the medium term outlook on inflation remains uncertain to some extent, the APP will run until 2023 at least and possibly much beyond since the ECB has modified its forward guidance to allow for some temporary inflation overshooting before starting to hike rates Moreover, the ECB focus on financing conditions will remain and the amount at stake to stabilise the credit market is much lower than on the public side.
