At its policy meeting on 4 June, the European Central Bank announced the size of its pandemic emergency purchase programme (PEPP) would be increased by EUR 600 billion. The PEPP is also extended until at least the end of June 2021. Italian government bond yields fell on the news.
A significant increase in the total purchase envelope
The PEPP, created on 18 March, was raised to EUR 1 350 billion. Since the start, EUR 234.7 billion worth of securities have been bought (as of 29 May), including EUR 186.6 billion in public securities.
Although president Christine Lagarde told the press conference that the ECB had deliberately been very active in the first two months of the programme, the current pace of purchases required an increase in the initial EUR 750 billion.
Moreover, the ECB Council had indicated as early as 18 March that it was is “fully prepared to increase the size of its asset purchase programmes and adjust their composition, by as much as necessary and for as long as needed”.
Recent comments had fuelled market expectations of a move in this direction. Prior to the meeting, expectations had centred on between EUR 500 billion and EUR 750 billion in additional purchases.
The amount of EUR 600 billion and the extension of the programme until next summer seem logical, but nonetheless are good news for eurozone bond markets – ECB support for the markets has been reinforced and is now assured for at least the next 12 months.
Some nuances, however
By stating that “the maturing principal payments from securities purchased under the PEPP will be reinvested until at least the end of 2022”, the ECB has, however, raised questions.
- Why did it announce a specific date, relatively soon, for the duration of the programme?
- Why was the formula used to present the APP programme not used for the PEPP?
The Asset Purchase Programme, created before the PEPP and better known as quantitative easing, is still active. Since 1 November 2019, it has consisted of monthly purchases of EUR 20 billion, plus a temporary envelope of further purchases of EUR 120 billion by the end of 2020 (added on 12 March).
From March to May, net purchases totalled EUR 127.8 billion. The ECB confirmed, “Reinvestments of the principal payments from maturing securities purchased under the APP will continue, in full, for an extended period of time past the date when the Governing Council starts raising the key ECB interest rates”. The reinvestment horizon looks much longer than that of the PEPP.
The ECB has chosen to run the two programmes in parallel, distinguishing between an emergency scheme to counter the effects of the pandemic and a more traditional approach to monetary policy to achieve its inflation target.
Very downbeat growth and inflation forecasts
According to staff projections, inflation will be significantly below the target of around 2% at 0.3% in 2020, 0.8% in 2021 and 1.3% in 2022, while the contraction in GDP of 8.7% in 2020 would be followed by a rebound by 5.2% in 2021 and 3.3% in 2022. Even in the most favourable alternative scenario presented by the ECB, inflation would be at 1.7% in 2022. In the worst-case scenario, it would be t 0.9%. This disinflationary trend suggest a long period of very accommodative monetary policy lies ahead.
Yet the ECB did not see fit to increase the size of the APP or the temporary envelope. President Lagarde even said that the increase in PEPP purchases should facilitate the return of inflation to the pre-pandemic trajectory.
Cuddling the hawks?
This rhetoric may seem odd given that the PEPP had been presented as an emergency tool and that it is the medium-term level of inflation that seems at risk. It can be explained a little better when one remembers that the PEPP was also presented as an instrument with “exceptional flexibility in terms of time, volume and allocation between countries and asset classes”, to quote the Governor of the Banque de France.
Yet the first available figures on the breakdown by country of public sector securities under the PEPP show that purchases appear to follow the ECB's capital key. Even so, some Governing Council members appear to have been concerned about these modest deviations from that standard.
Against this background, and while the German Constitutional Court is still waiting to be convinced of the legitimacy of the Bundesbank's participation in the APP, one could imagine that the ECB opted not to modify this programme to avoid provoking further dissension in the council. It could be that the 2022 date is intended to reassure sceptics about the PEPP's temporary nature.
Maintaining calm between doves and hawks requires strong diplomatic skills, even in exceptional circumstances. Now that the critical phase (i.e. a risk of dislocation and fragmentation of markets) appears to have passed, further adjustments can be made as the situation develops, sometimes surprisingly as in the case of the totally unexpected rise in US employment in May.
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