ECB View: Taper talk dismissed as premature – The ECB made no new policy announcements or changes in forward guidance at the April Governing Council meeting earlier this afternoon. There were, however, five interesting points from the press conference:
No taper – ECB President Lagarde made it clear that the Governing Council had not discussed the phasing out of net purchases under the PEPP at the meeting as it was ‘premature’. This was in response to a question pointing out that a number of hawkish national central bank heads had recently signalled that they would be in favour of tapering purchases in the second half of the year. Her comments suggest that this is not a majority view in the Council.
Focus still on financing conditions – The Governing Council judged that ‘financing conditions have remained broadly stable recently after the increase in market interest rates earlier in the year, but risks to wider financing conditions remain’. As such the Council reconfirmed ‘it’s very accommodative monetary policy stance’ and expected ‘purchases under the PEPP over the current quarter to continue to be conducted at a significantly higher pace than during the first months of the year’. In our view there remains some confusion about what the ECB is trying to achieve. Chief Economist Philip Lane had suggested earlier that the aim was to return to December levels of the yield curve, but the latest remarks at the press conference and ECB purchase behaviour suggest that they are content to roughly stabilise yields.
Economic assessment unchanged – The ECB’s assessment of the economic outlook and risk spectrum remained unchanged. Mrs Lagarde noted that recent data were broadly consistent with the ECB’s March projections. The ECB continued to judge that ‘progress with vaccination campaigns, which should allow for a gradual relaxation of containment measures, should pave the way for a firm rebound in economic activity in the course of 2021’. It repeated that ‘while the risks surrounding the euro area growth outlook over the near term continue to be on the downside, medium-term risks remain more balanced’. At the same time the ECB sounded more convinced that the rise in inflation was transitory and continued to assert that ‘underlying price pressures remain subdued in the context of significant economic slack and still weak demand’.
Eurozone ≠ US – The ECB President was asked about whether the timing of a tapering of net asset purchases by the Fed was a consideration in terms of the Governing Council’s deliberations. She made it clear that the economy of the eurozone was not on the same ‘page’ as that of the US and therefore monetary policy would not move in tandem. Indeed, she signalled given the different outlook for the economy and inflation, the ECB’s exit would likely significantly lag that of the US. We judge that the big difference between the outlook in the US compared to the eurozone is that the fiscal stance is far more aggressive in the former.
Call to speed up fiscal support – Indeed, the Governing Council strengthened its call for the Recovery Fund to become operational and therefore provide fiscal support without further delay. In particular, it underlined ‘the key role of the Next Generation EU package and the urgency of it becoming operational without delay. It calls on Member States to ensure a timely ratification of the Own Resources Decision, to finalise their recovery and resilience plans promptly and to deploy the funds for productive public spending, accompanied by productivity-enhancing structural policies’. In our view, even assuming the funds are rolled out according to plan, the aggregate fiscal stimulus in the eurozone falls short in the sense that an output gap will remain in the coming years.
Some last thoughts on ECB policy, inflation and bond yields – We think the key point that will continue to underpin the ECB’s monetary policy is that inflation is set to significantly undershoot the ‘close to but below 2%’ goal in 2022 and 2023. In addition, that goal will likely be made more ambitious following the ECB’s strategy review that will be announced in the autumn of this year. At a minimum, the ECB will switch to a goal of ‘symmetry around 2%’. Such a change, would likely mean a continued undershoot of the new goal in 2024 as well. Our own inflation projections for 2022-2023 are actually even below the ECB’s. The read through to bond yields is the following. The most important driver of long rates is the outlook for short rates over the coming years. A policy rate hike is unlikely in the coming years, and markets are too optimistic in pricing in even a gradual hike cycle. If one does not believe there will be a rate hike in coming years, it is reasonable to expect the 10y Bund yield to drift back towards the deposit rate. So even though the ECB’s ‘PEPP step up’ strategy is not very convincing, weak inflation fundamentals will be.