ECB View: Central bank signals long-term support for governments and banks – ECB President Christine Lagarde made explicit what has been implicit over the last year: the real game in town is fiscal policy and the ECB sees its job as facilitating fiscal stimulus at favourable financing conditions. In a remarkable speech at the ECB Forum on Central Banking, Ms. Lagarde asserted that ‘these are the times when fiscal policy has the greatest impact’ as ‘when interest rates are already low and private demand is constrained by design – as is the case today – the transmission from financing conditions to private spending might be attenuated’. She explained that ‘fiscal policy can respond in a more targeted way to the parts of the economy affected by health restrictions’ and can also ‘break paradox of thrift dynamics in the private sector when uncertainty is present’.
As a result, ‘while fiscal policy is active in supporting the economy, monetary policy has to minimise any crowding-out effects that might create negative spillovers for households and firms. Otherwise, increasing fiscal interventions could put upward pressure on market interest rates and crowd out private investors, with a detrimental effect on private demand’.
Furthermore, as well as facilitating fiscal policy, the ECB also intended to ‘continue supporting the banking sector to secure policy transmission and prevent adverse feedback loops from emerging. Firms are still dependent on new flows of credit. And those that have borrowed heavily so far need certainty that refinancing will remain available on attractive terms in order to avoid excessive deleveraging’.
Meanwhile, in achieving these objectives, the ECB President made clear that ‘what matters is not only the level of financing conditions but the duration of policy support, too. All sectors of the economy need to have confidence that financing conditions will remain exceptionally favourable for as long as needed – especially as the economic impact of the pandemic will now extend well into next year’.
Finally, the ECB remains cautious about the economic outlook despite recent vaccine developments. Ms Lagarde explained that ‘while the latest news on a vaccine looks encouraging, we could still face recurring cycles of accelerating viral spread and tightening restrictions until widespread immunity is achieved’. In addition, ‘recovery from a services-led recession tends to be slower than from a durable goods-led recession, as services create less pent-up demand than consumer goods’, while ‘services-led recessions have an outsized effect on jobs’.
Overall, the ECB President’s comments confirm that a sizeable ECB stimulus package is still very much on the cards despite the positive vaccine news. In addition, the central bank will likely be focused on ensuring that there is a large envelope of net asset purchases available for next year to absorb rising public sector net supply. The ECB will also want to signal that asset purchases will be in place for a long time. Finally, further measures to support the banking system seem likely.
Our base case remains for a EUR 500bn step up in the PEPP in December. The amount available in 2021 left over from the current PEPP envelope is projected at EUR 500bn, meaning total PEPP firepower of EUR 1000bn for 2021. The risks to the size of the step up are to the downside, given the recent slow pace of net purchases could mean that there is more left over in the current envelope than we are assuming.
In addition, we think the ECB will signal net asset purchases will continue for a very long time. The duration of PEPP will be expanded through to end 2021. On the same theme, we expect the APP – the programme which will likely continue after the end date of the PEPP – to be stepped up by EUR 10bn a month taking the total APP amount to EUR 360bn in 2021. The ECB will likely make changes to increase the headroom in this programme going forward, such as removing the minimum maturity threshold for public sector purchases and increasing the issue(r) limits for regional and agency bonds (we will discuss this in more detail in an upcoming publication).
Meanwhile, we expect a series of measures to support banks. The tiering multiplier will likely be gradually increased in coming months with the first step in December, while TLTRO conditions are set to be loosened further (again we will communicate further details on these points further).
Finally, we do not expect a cut in the deposit rate. We think this is a tool to curb euro strength, while the euro’s upward trend has recently halted. However, a second upward leg of the single currency would make a rate cut a distinct possibility.