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Life after PEPP: Five questions for the ECB

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Economy25 minutes ago (Dec 13, 2021 07:15)

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© Reuters. FILE PHOTO: President of the European Central Bank (ECB) Christine Lagarde speaks as she takes part in a news conference on the outcome of the Governing Council meeting, in Frankfurt, Germany, October 28, 2021. REUTERS/Kai Pfaffenbach/File Photo/File Phot

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By Dhara Ranasinghe and Saikat Chatterjee

LONDON (Reuters) – Thursday’s European Central Bank meeting looks like a crucial one – officials are set to call time on pandemic-triggered stimulus. The question now is how much support to leave in its place given the emergence of the Omicron COVID-19 variant and uncomfortably high inflation.

Here are five questions on the radar for markets.

1. What can we expect on Thursday?

The ECB is likely to confirm that the 1.85 trillion euro ($2.09 trillion) Pandemic Emergency Purchase Programme (PEPP), launched in March 2020 at the height of COVID-19-induced market turmoil, will end next March.

It’s also likely to flag that the pace of bond buying will slow in the first quarter of 2022.

The ECB has said it will reinvest funds from maturing bonds in PEPP back into the market at least until end-2023. It could also keep the option of extending the scheme if conditions deteriorate.

ECB President Christine Lagarde has said policy may be set for a relatively short period given renewed uncertainty.

“It’s a delicate moment, the ECB will have to take an important decision regarding asset purchases and there are shocks that go in both directions,” said BNP Paribas (PA:BNPP) chief global economist Luigi Speranza. (Graphic: Weekly PEEPP, https://fingfx.thomsonreuters.com/gfx/mkt/movanqqbkpa/Weekly%20PEPP.JPG)

2. How will the Asset Purchase Programme (APP) pick up the slack when PEPP ends?

ECB monthly bond purchases of 20 billion euros under the six-year old APP are expected to double from April to stabilise long-term inflation at 2% and replace much of the lost PEPP stimulus.

But the decision is contentious. ECB hawks warn against adding to APP when inflation could remain too high longer-term. Doves want to stick with ultra-easy monetary policy because long-term price pressures remain weak.

According to a source-based report, a compromise is forming around beefing up APP but with limits on the size and time of the commitment.

The ECB could approve a purchase envelope until end-2022, with the caveat that not all of it must be spent. Alternatively, it could lift bond buys for a shorter period with the pledge that purchases would still continue thereafter, but that their size would be discussed later and would probably fall.

“There are lots of moving parts,” said Danske Bank chief strategist Piet Haines Christiansen, noting that ECB hawks might favour the idea of an APP envelope because it would be limited in volume and time. (Graphic: APP Program, https://fingfx.thomsonreuters.com/gfx/mkt/zdvxoxxjrpx/APP%20Program.JPG)

3. Does the ECB see inflation as transitory?

U.S. Federal Reserve chief Jerome Powell says “transitory” is no longer right to describe rising inflation.

With euro zone inflation at a record-high 4.9%, Lagarde will be pressed on the trajectory. She recently described the profile as a “hump,” adding that a hump “eventually declines.”

Thursday’s ECB economic forecasts are expected to show consumer price inflation contained at around 1.8% in 2024.

Also key is whether high inflation fuels wage demands, lifting longer-term price pressures.

ECB Vice President Luis de Guindos said last week that inflation will take longer to fall but so far there was no evidence higher prices are embedding in wages. (Graphic: EZ inflation, https://fingfx.thomsonreuters.com/gfx/mkt/gdvzymmjmpw/EZ%20inflation.JPG)

4. What does Omicron mean for the economic outlook?

Central banks are trying to assess the extent to which Omicron exacerbates supply chain bottlenecks and weighs on economic activity via fresh restrictions.

Lagarde believes Europe has adapted well to life under the pandemic and economists say that – so far – Omicron does not change the economic outlook dramatically. (Graphic: COVID And europe, https://fingfx.thomsonreuters.com/gfx/mkt/znpnexxqkvl/COVID%20And%20europe.JPG)

5. How much flexibility will the ECB allow itself post PEPP?

Bond markets will want a sense of how much of the flexibility embedded in PEPP will be transferred to APP, even if some decisions will be postponed.

Some analysts do not expect the ECB to raise issuer limits or drop the capital key for APP, as both were for its pandemic scheme, because doing so could trigger legal objections.

Greece could come up. Its bonds are included in PEPP but not APP, which requires an investment-grade rating that Greece lacks. The ECB might stress that Greek bonds will remain supported as PEPP bond redemptions will be reinvested. (Graphic: Europe bond spreads, https://fingfx.thomsonreuters.com/gfx/mkt/jnvweaakjvw/Europe%20bond%20spreads.JPG)

Life after PEPP: Five questions for the ECB

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