ECB: Delivering as Needed

Published on June 1, 2020
SGH Insight
[T]he central bank could decide to wait until its July meeting before hiking the PEPP in order to more fully assess the impact of the existing stimulus injections, the exact need for additional bond purchases, and the damage to the Eurozone economy.

It could, but it won’t…

With no inflation in sight, a risk/reward consensus that favors doing more, and not less, and monetary and fiscal authorities around the world still pledged to do “everything it takes” to fight the COVID-19 recession, a pause now against expectations would unnecessarily shock and jeopardize the hard-won stability and compression in rates the ECB has already achieved across the Euro-system.

So while there is always the option to wait, ECB officials have continued to communicate they are ready to deliver on the additional stimulus that is obvious to all will be needed to counteract the deepest contraction ever in the Eurozone economy, and sooner, rather than later.
Market Validation
(Bloomberg 6/4/20)

Europe’s Stoxx 600 turns slightly positive, paring a drop of as much as 0.8% after ECB boosts its stimulus program.
Banks almost wipe out drop of as much as 2.2%
ECB adds EU600b to its pandemic purchase program and extends it to at least June 2021, says will reinvest PEPP holdings until at least end of 2022

(Bloomberg) -- Italian bonds and the euro reversed losses after the European Central Bank boosted its emergency bond-buying program by more than expected.
The yield on Italy’s 10-year bonds fell 16 basis points to 1.39% and the euro extended its rally to the longest since 2011 after the ECB topped up its pandemic stimulus by 600 billion euros ($674 billion), beating estimates by 100 billion euros.

*Euro Rises to $1.1243 After ECB Decision From $1.1203 Beforehand

Markets are certain the European Central Bank Governing Council will “top-off” and extend beyond 2020 its 750 billion-euro Pandemic Emergency Purchasing Program when it convenes this Thursday, June 4.

** We believe market expectations are right, and as such we would be remiss to leave SGH 5/26/20 report, “ECB: A Potential Pause,” standing with no further context going into Thursday’s meeting. **

That report conveyed an off-consensus message from ECB sources that when Chief Economist Philip Lane presents his policy options to the Governing Council next week, the central bank could decide to wait until its July meeting before hiking the PEPP in order to more fully assess the impact of the existing stimulus injections, the exact need for additional bond purchases, and the damage to the Eurozone economy.

It could, but it won’t.

In the run-up to the current, traditional one-week “purdah” communications black out period, ECB officials have done nothing to dispel market expectations that an announcement of further bond purchases will accompany the (also widely expected) severe downwards quarterly forecast revisions that will be unveiled on Thursday.

With no inflation in sight, a risk/reward consensus that favors doing more, and not less, and monetary and fiscal authorities around the world still pledged to do “everything it takes” to fight the COVID-19 recession, a pause now against expectations would unnecessarily shock and jeopardize the hard-won stability and compression in rates the ECB has already achieved across the Euro-system.

Furthermore, while the German Constitutional Court challenge to the Bundesbank’s participation in the ECB’s original PSPP bond program has yet to be addressed, we believe a direct linkage of further bond purchases with the central bank’s quarterly forecast will help on the margins in preempting the continued politicization of ECB actions by the GCC plaintiffs – especially with the new PEPP program, where the Capital Key system for allocating bond purchases has in effect been suspended to push liquidity to the Eurozone countries and markets that need it the most.

So while there is always the option to wait, ECB officials have continued to communicate they are ready to deliver on the additional stimulus that is obvious to all will be needed to counteract the deepest contraction ever in the Eurozone economy, and sooner, rather than later.

That includes communications from the highest levels of the ECB, including Governor Francois Villeroy de Galhau, Executive Board Member Isabel Schnabel, and even President Christine Lagarde, who are all well-aware of market expectations, and of the impact of their guidance and words on Thursday’s meeting.

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