The resurgence and spike in COVID cases across Europe over the last couple of weeks has been considerably more severe than expected and has raised the alarm bells at the European Central Bank and in capitals across the region.
ECB officials confirm that next week’s Governing Council meeting will be too soon for additional monetary policy measures, as the next six weeks will provide more clarity on the magnitude of the COVID wave, as well as on the magnitude of fiscal support that can be expected to supplement their monetary policy stimulus – particularly at the national level.
*** But come December, the Governing Council will review and, as needed, adjust both the current “envelope” of the Pandemic Emergency Purchase Program as well as the parameters of its standing bond buying Asset Purchase Program. With forecasts looking to be dropped further, a commitment to extend bond purchases beyond the middle of 2021 is highly likely then, even as ECB officials note that the central bank, having conducted “only” 600 billion of its 1.35 trillion PEPP purchases as of last week, has plenty of money to cover purchases for now. ***
*** It appears that ECB officials at that point will also be leaning toward transitioning additional purchases into the “normal” APP from the emergency PEPP program. While ECB officials note that rolling the PEPP into the APP would be a “technical” matter, it would also have market implications in that it would sacrifice some of the flexibility that the PEPP currently provides to stray from the ECB Capital Key with in essence zero impunity, even while providing additional across the board stimulus to the Eurozone. ***
*** Interest rates are of course always part of the tool kit, and that will be stressed by ECB officials repeatedly as the Euro keeps climbing against a Federal Reserve induced weak dollar. But as things stand, a rate cut into even deeper negative territory remains a distant second option to stepped up bond purchases and does not appear to be on the table in any serious way. ***
A Tough Two Weeks
ECB officials note that as recently as a week ago the drift up in COVID cases – and commensurate risk to the economic rebound – was still within the central bank’s baseline forecast scenario.
But numbers are now suddenly rising quite rapidly, including with recent spikes in Germany even as Spain has shown some small signs of stabilization, albeit also at worrisome rates. Complicating matters, mainly symptomatic patients are now being tested, resulting of course in positivity percentage rates that are well in the teens, but more to the point, also crowding out efforts to manage the outbreak in the population at large with broader tests and aggressive contact tracing.
While all governments are fiercely resistant to shutting their economies down again, “local confinements” have already been put in place in many regions, hitting tourism and leisure hard, and raising renewed concerns over retail sales and the holiday shopping season. In the words of one ECB official, the fourth quarter will be “not brilliant.”
But more importantly for monetary policy, with the pandemic still casting its long shadow on economic activity, and broad vaccine deployment elusive still, officials now expect the growth outlook for 2021 to be marked down in the ECB’s December quarterly forecast revisions.
On the brighter side, industrial activity across the Eurozone still appears to be holding up, reflected not just in PMI survey measures but in real-time transportation and trucking data as well.
But with downside risks growing, that is of little solace to EBC officials, who will very likely be grudgingly forced to delve again into their stimulus toolbox at their December 10 Governing Council meeting. In the meantime, officials in the Frankfurt Eurotower will be exhorting their European capital colleagues to keep the foot pressed hard on the fiscal accelerator for at least one more year.
The Fiscal Impetus
While market attention is mostly focused on pan-European fiscal measures, ECB officials say the most direct fiscal impetus for 2021 will still come from the national side.
France and Germany have already submitted their programs to Brussels for review, but ECB officials will be looking at other budgets as they come in to see the extent to which national income support and furlough type schemes are being continued into 2021.
As to the pan-European efforts, final ratification of the 750 billion Euro Recovery Fund is still being held up by disputes over conditionality, particularly the “rule of law” provisions directed mainly at Hungary’s government under Prime Minister Viktor Orban and at Poland’s Law and Justice regime.
Our understanding is that Italy and Spain, eager to get the fund off the ground, have been pressuring the European Parliament to quietly back down from the “rule of law” fight. But the European Union, for all its enormous efforts to establish a collectivized fiscal support backstop for the region, in the meantime may in effect have fallen victim to the ECB’s success.
In a particularly ironic turn of events, ECB officials note that sovereign yields have been driven so low that Italy’s Five Star Movement, for example, is continuing to insist that the government raise money on the markets and tap the European facilities only for grants, shunning loans that would carry with it any conditionality whatsoever when the free market alternative is so cheap.
That peripheral yields remain at record lows while this debate goes on, and with ESM reform not even yet signed, perhaps says it all.