- The ECB delivered roughly as expected by increasing its PEPP envelope by DKK 600 billion. EUR 1.350 billion At the same time, it announced that it had decided to reinvest PEPP holdings at least until the end of 2022.
- Markets reacted with risk, given that Italy tightened 20bp.
PEPP was increased …
At the monetary policy meeting that ended today, the ECB decided to increase the PEPP envelope by $ 600 billion. EUR 1.350 billion EUR, which was slightly more than our estimate and consensus of DKK 500bn. EUR. In general, the ECB delivered as we expected as described in ECB Research – PEPP is ongoing, May 28. With the new increased envelope, PEPP would be exhausted by the end of February 2021 if the ECB does not lift the envelope again or the purchase rate will have to decline.
Looking ahead, with the larger PEPP envelope, we do not expect the ECB to publish further measures at this time. During the press conference, Christine Lagarde was relatively balanced in her assessment, albeit as a recognition that there is a risk of the downside of the growth forecast of -8.7% for 2020 (see later in this document). Today’s decision was for a broad consensus, while there was unanimity to do something.
Lagarde’s answer to questions about the German Constitutional Court was as expected when she referred to the European Court of Justice ruling on PSPP legality and to the GCC decision addressed to the Federal Day.
… And markets liked it
Fixed income markets reacted positively to the slightly higher package than expected, particularly led by Italy, where we saw BTP-Bund spread the tightening by 20bp.
We now have more ECB easing but a stronger EUR. In our view, this is questionable as these actions really involve macroeconomic tail risks. Thus, the fall in uncertainty becomes a currency-strength propellant.
In order to continue the competition in EUR / USD, the global investment environment must continue to favor a rotation towards “undervalued” assets. Look like a simple rule of thumb for the world canary in the coal mine to measure this. In short, we need at least one of DAX, TRY, ZAR or BRL to continue to increase approx. 1-2% per day to further support the EUR, but this may be related to us for a while longer. In fact, at the moment, we don’t see much in the way of going to 1.14 – aided by speculation about a Brexit compromise – although the latter is unlikely to be delivered in the short term, in our opinion.
The modest economic outlook determines the expansion of PEPP
As expected, the new ECB staff forecasts painted a serious economic outlook with significant downward adjustments in inflation and GDP forecasts, which Lagarde said were an important trigger for the PEPP enlargement. Although there have been some improvements in high-frequency data, these remain low in light of the significant decline in recorded activity, according to Lagarde. Following a GDP decline of -8.7% in 2020 in the base scenario, the ECB expects the euro area economy to expand by 5.2% in 2021. This scenario is more negative than our expectation of a -6.7% contraction in 2020 (see The big picture – Re-opening, recovery and risks, June 2) but both the ECB and we still expect a gradual recovery in the euro area to unfold in the second half of 20. That said, the risk remains skewed downwards and the ECB’s negative scenario could see GDP falling by -12.6% in 2020 and depressing HICP inflation to just 0.9% in 2022 due to significant labor market slack.
The ECB expects weaker demand to exert pressure on inflation, which is only partially offset by upward pressure on supply constraints. Although the ECB revised the HICP and core inflation outlook significantly lower across the horizon, not least due to a stronger efficient euro and lower oil prices fed into the forecast, it remained on a sloping path where core inflation reached 0.9% in 2022 We broadly agrees with the ECB that anti-inflationary forces will prevail in the short term, but in our view, the unprecedented monetary / fiscal relief may limit the damage to the labor market and cost pressure inflation in some industries. space for a reflection coil to eventually arise (see Eurozone research – The road to improvement, May 14).