Global Daily – From PEPP to APP and forward guidance
ECB View: June likely too early to slow PEPP but transition likely later this year. The ECB Governing Council will reassess the pace of net purchases for Q3 under the PEPP at its June monetary policy meeting. This follows its announcement that it would step up purchases in Q2 compared to Q1 levels. Indeed, so far it has done so, but only modestly.
A number of – the usually more hawkish – Governing Council officials have suggested that they would be in favour of slowing purchases again in Q3. However, we do not think that the Governing Council as a whole will move in this direction. This is because the euro sovereign yield curve has remain elevated despite the recent higher purchase pace and the central bank has communicated that it would do what is necessary to anchor bond yields.
The ECB would only be comfortable with the higher level of yields if the outlook for inflation over the medium term had significantly improved since March. However, this is unlikely to be the case. Although one can be more confident of strong economic growth during the rest of the year given that the vaccine rollout has gathered pace, this is very much in line with the ECB’s base scenario. At the same time, recent reports suggest that underlying inflationary pressures remain extremely subdued. So a slowdown in the PEPP purchase pace can only be really be justified by either a sharp fall back in bond yields by the time of the June meeting with an unchanged inflation outlook, or yields remaining elevated but with the inflation outlook higher. In the absence of these developments, keeping the PEPP at the recent pace would make sense. Having said that, it must be noted that the Governing Council is becoming more divided and President Lagarde will have her work cut out to achieve consensus.
Looking further forward, it does seem likely that the ECB will start to prepare the ground for a transition from the PEPP being the main instrument of monetary policy to the APP and forward guidance on policy rates coming to the forefront. If the ECB were to sustain the PEPP at recent levels in Q3, before slowing down to the pace seen earlier in the year thereafter, it has enough room under the current envelope to continue until March 2022. The ECB may well end the PEPP at that point given that the pandemic is over. However, easy monetary policy will likely continue for some time. As we noted in an earlier note (see ) policy rates are unlikely rise over the coming years given the inflation outlook. In addition, the APP will continue until shortly before the ECB raises rates, suggesting that asset purchases will be with us for some time even after the PEPP ends.
Having said that, ending the PEPP and moving to the APP will entail quite a slowdown in the pace of purchases and will be seen as a tapering by financial markets. To prevent a ‘taper tantrum’ it is crucial that the ECB keeps policy rate expectations in check. Indeed, in our view previous tantrums were driven by investors speculating that tapering will be quickly followed by policy rate hikes. The ECB can manage these expectations by strengthening its forward guidance to signal policy rates will likely remain on hold through its current forecasting horizon. It can make this credible by also concretely committing to keeping the APP programme going through much of this period as markets do understand net purchases would need to cease entirely for policy rates to go up. (Nick Kounis)