The ECB looks set to conclude its pandemic response program (PEPP) and step up its asset purchasing program (APP) in its stead.
In short, following a joint assessment of the inflation outlook and financing conditions, we think the ECB will end its pandemic emergency programme (PEPP) in March or April 2022.
ECB President Madame Lagarde reminded us at September’s meeting that the PEPP will only end once the pandemic emergency is over. This follows ECB Chief Economist Philip Lane’s comments in a recent interview with Reuters, where he described the PEPP phase as lasting “while the downside risks (of the pandemic) is substantial”. In the past, the ECB has also made it clear that the objective of the PEPP is to bring inflation back to pre-pandemic levels. Once that is achieved, the ECB could propose an end to PEPP.
The ECB did not answer any questions on the future of the PEPP at September’s meeting, but prepared markets for a decision in December. By then the ECB expects growth to have returned to its pre-pandemic level.
Assuming the pandemic remains under control this winter, we think the ECB will be in the perfect position to end the PEPP, which is an emergency programme as Madame Lagarde emphasised. We maintain our ECB view as follows:
The ECB’s more upbeat language on inflation and the euro area’s economic outlook, together with the upward revisions to the ECB’s inflation projections were important. Taken all together, we believe these developments support our view that the PEPP will end in Q1 2022.
The ECB will publish its 2024 inflation for the first time in December. With the 2023 inflation forecast currently at 1.5%, and the Q4 2023 inflation forecast at 1.6% y-o-y, we think it will likely publish a 2024 inflation forecast at or above 1.6% y-o-y in December. If that materialises, it would imply inflation having returned to its pre-pandemic level by December.
The Governing Council dismissed the recent upward surprises in inflation, and maintained its view that the rise in inflation will be temporary. Madame Lagarde highlighted some progress in underlying inflation during the press conference; however, she also said once more that most measures still point to medium-term inflation being well below the ECB’s target.
The APP envelope seems to be the perfect compromise between the hawkish and dovish views in the Council. A larger expansion of APP monthly purchases, while possibly supported by some of the more dovish ECB members, may face resistance from the hawkish side, most of all at a time when inflation will likely be printing well above 3% y-o-y, in our view. A temporary envelope to be used flexibly, only if market conditions make it necessary, would be much easier to digest for the hawkish members in the Council.
Longer term, we think stronger APP purchases will show the ECB’s renewed commitment to reach its inflation target, especially after the announcement of its new rates forward guidance in July.
There are several key risks to the view presented above, as it represents just one of the many ways the ECB could adjust its purchases at the end of this year.
The way in which the ECB adjusts its purchases next year will be relevant to markets to the extent that any increase in the APP may be perceived as a longer-lasting form of monetary policy stimulus than an expansion of the PEPP. While the ECB’s monthly asset purchases will likely decline next year once the PEPP ends, the good news for markets is that higher APP purchases are here to stay, we believe. We expect APP purchases to run at €40bn per month at least until the end of 2023.
Read the full article "Fore! ECB on track to end PEPP in spring 2022" on the here.
Chief UK & Euro Area Economist
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