After the big move in June, ECB is likely to keep its powder this month. At this week’s meeting, we expect the central bank to acknowledge the improvement in economic activities, mainly driven by consumption. However, the members will remain cautious, highlighting the high uncertainty and downside risks to economic outlook. On the monetary policy, we expect more clarity on PEPP, especially after some members arguing that the 1.35 trillion euro envelope is a ceiling. Despite these comments, we expect ECB to reiterate the commitment to maintaining “substantial monetary policy stimulus”.
Economic indicators released since the June meeting have revealed a fast pace recovery in the Eurozone. Retail sales jumped -17.8% m/m in May, after contracting -12.1% previously. From a year ago, the reading dropped -5.1% in May, after a -19.6% decline a month ago. This came in better than consensus of a -7.5% fall. On inflation, the flash headline HICP climbed +0.3% y/y in June, from +0.1% a month ago. Core HICP eased to +1.1%, from +1.2% in May. Business surveys show that considerable improvement in market sentiment. For instance, economic sentiment rose +8 points to 75.7, while industrial sentiment improved to -21.7 from -27.2 in May. Separately, the Markit PMI report reveals that recovery has been underway in both manufacturing and services activities. Eurozone PMI rose to a four-month high of 48.5 in June, from May’s 31.9. While staying in the contractionary territory, the improvement was seen in major Eurozone economies including Germany, Italy and Spain. The corresponding index for France jumped to 51.7 from 32.1, signaling that the economy has returned to expansion in June.
We expect policymakers to acknowledge the relatively fast economic recovery from the peak of the coronavirus outlook. They would also attribute it to the expansionary monetary policy and fiscal stimulus. At the June meeting, ECB raised the size of the pandemic emergency purchase program (PEPP) by 600B euro to a total of 1,350B euro. The increase was 100B euro higher than what we had anticipated. Meanwhile, the program is extended to the end of June 2021, and could continue beyond this until the central bank “judges that the coronavirus crisis phase is over”. The central bank also announced the plan to reinvest the proceeds from the PEPP purchases until at least 2022. Other policies, including policy rates, APP and forward guidance, stays unchanged.
Over the past weeks, some ECB members, such as Klass Knot, Yves Mersch and Isabel Schnabel, argued that it might not be necessary to use the full size of PEPP. Some even indicated that the size of 1.35 trillion euro is a ceiling. We believe these comments were made against a backdrop of positive economic indicators. Yet, these should not be interpreted as a change in ECB’s monetary policy stance.
ECB at the June meeting suggested that the primary goal of PEPP is to bring inflation back to the “pre-COVID inflation path”. This guidance might imply that the central bank could run (or expand further) the PEPP so that inflation return to +1.6% by 2022 as projected in March. Since ECB revised lower the 2022 headline projection to +1.3% in light of the damage done by the pandemic, we anticipate the central bank would need to continue with substantial asset purchases in order to achieve the goal set in March.