Although the ECB left policy unchanged, it signalled very strongly that a stimulus package will be announced in December amid growing downside risks. It noted that ‘in the current environment of risks clearly tilted to the downside, the Governing Council will carefully assess the incoming information…the new round of Eurosystem staff macroeconomic projections in December will allow a thorough reassessment of the economic outlook and the balance of risks. On the basis of this updated assessment, the Governing Council will recalibrate its instruments’.
In the press conference following the statement, ECB President Lagarde made it clear that all members of the Governing Council agreed that action would be necessary and that committees were already at work assessing how to calibrate the central bank’s response. In addition, she stressed that the response would not only involve an increase in the PEPP but that all instruments would be considered. This suggests we will see a package of measures. Finally, Ms. Lagarde strongly signalled that the weekly asset purchases would be stepped up in the meantime.
We think that asset purchases under the PEPP will still very much be the central plank of the December package. The ECB judges that QE has had the biggest impact on growth and inflation relative to its other policy tools. In addition, the PEPP has much more flexibility than the APP. Although the APP will eventually need to be stepped up and to take over from the PEPP, it might be too early to make this transition. The Governing Council can easily make the case that it is still dealing from the fall-out from the pandemic, which is still ongoing, so the use of the PEPP is justified. We have long expected the PEPP to be increased by EUR 500bn in December. However, it seems likely given the ECB’s comments that the monthly purchases under the APP will also be increased from the current EUR 20bn. By increasing the APP, the ECB may have the intention of signalling the longevity of significant asset purchases long after the PEPP ends given downside risks to inflation. We will be reviewing our APP call and the size of overall asset purchases in the coming days.
Meanwhile, the ECB will likely announce further measures to support banks. The TLTRO conditions could be further eased for upcoming tranches. This could include the volume as well as the lending rate. We will also firm up the exact calibration of our TLTRO scenario in the coming time. In addition, the ECB may well decide to increase the multiplier for the calculation of the allowance of excess reserves that banks can hold free of charge. An increase in the tiering system ratio could modestly reduce the burden of direct costs to banks from negative interest rates. With excess liquidity surging and interbank rates having fallen sharply, the case for this move is strong.
Finally, we still do not expect a reduction in the deposit rate. Although the ECB has kept the option of a cut in the deposit rate open, the Governing Council has refrained from using it. ECB Executive Board member Isabel Schnabel explained in April that ‘a further cut in our main policy rate – the deposit facility rate – would have been unlikely to support sentiment and market functioning at a time when banks’ profitability was already expected to come under additional pressure due to the crisis’. It seems that a deposit rate cut would only be considered seriously as an option in the case of an ongoing sharp appreciation of the euro. However, the euro’s upward trend has fizzled out over recent weeks.