Global Daily – QE as far as the eye can see

by: Aline Schuiling , Nick Kounis

ECB View: A package to facilitate fiscal stimulus and bank lending – The ECB announced a package of measures that was broadly consistent with our own and market expectations. The key focus was in two areas. First, it made available sufficient firepower under the PEPP in order to absorb next year’s huge public sector bond supply, while keeping bond yields low. The PEPP will be stepped up by EUR 500bn, adding to the EUR 600bn still available in the programme. The duration of the programme was also extended to March 2022, while reinvestments will continue until at least the end of 2023. Meanwhile, the APP will continue at EUR 20bn a month. This means EUR 1.34 trillion in asset purchases is available over the next year or so.

Second, it took measures to secure a longer period of easy financing conditions for the banking system. It added three more tranches to its TLTRO-III programme (to be conducted between June and December 2021), which means funding ultimately up until the end of 2024. In addition, banks can benefit from the most favourable lending rate (-1%) for a year longer, to June 2022. Finally, banks can borrow even more from the ECB under the programme (now 55% of the total stock of eligible loans compared to 50% previously).

With these measures, the ECB has now put the ball in the court of governments and banks to help sustain the expected strong economic growth next year, which will initially be triggered by the containment of the virus and lifting of restrictions. The test will be whether governments deliver a new round of aggressive fiscal stimulus, and whether banks loosen lending conditions.

ECB has never been this gloomy about medium-term inflation outlook – Meanwhile, the ECB also published its new ECB staff macroeconomic projections for the euro area. Its new forecasts for GDP growth now include the impact of the second wave of Covid-19 infections and the new lockdown measures at were implemented as from mid-October onwards. Consequently, the central bank lowered the growth outlook for 2021 (to 3.9% from 5.0%) and raised its projection for 2022 (to 4.2% from 3.2%), as the rebound in activity following the pandemic will be later than had been expected in the September projections. In line with the tradition the central bank added one year to its forecasting horizon in December. It expects GDP to expand by 2.1% in 2023, which would be somewhat above the trend growth rate of around 1.25-1.5%. According to ECB president Christine Lagarde, the risks to the growth outlook remained tilted to the downside, but had become less pronounced.

The ECB’s projections for inflation during the years 2021 and 2022 were downgraded modestly taking them to even lower levels.  The forecasts for core inflation (excluding the volatile components food and energy) in 2021 and 2022 were revised 0.1pp lower by the central bank (to 0.8% and 1.0%, respectively). More interestingly the first estimate for core inflation in 2023 was published. It turns out that the central bank expects core inflation to be only 1.2% in 2023 (headline inflation is expected to be 1.4% that year), so well below the ECB’s goal of close to 2%. Historically, the ECB has always optimistically forecast that inflation would move closer to its target in the medium-term when it extended its projections by a year. The central bank’s first estimate for core inflation in 2022 (published in December 2019) was 1.6% and its first estimates for 2021 and 2020 each were 1.8%.

QE will go on and on and on – Despite the announcements made today, the ECB is deeply unsatisfied with the inflation outlook. That is not surprising, because even in 2023 inflation will be nowhere near its target. Indeed, even these forecasts for inflation look optimistic to us given that a lot of spare capacity will remain in the economy over the coming years. This likely means that aggressive asset purchases will need to continue in the coming years as a way of supporting demand and inflation directly, but more importantly to facilitate ongoing fiscal stimulus without triggering a sharp rise in yields. (Nick Kounis & Aline Schuiling)