ECB preview: more open mouth operations, but only that?
Economic activity is still subdued across Europe as the resurging virus and accompanying restrictions keep weighing on the service sector. Manufacturing, on the other hand, is experiencing a renaissance and is - at least partly - compensating the losses in the service economy. PMIs for both Germany and Italy indicated a moderate expansion in February. Inflation has risen close to 1% in February on the back of the German VAT hike. Together with the base effect of energy prices, these temporary factors will push inflation up even more in the second half the year. Average annual inflation could reach 1.5% this year. Surging commodity prices, transportation costs, and factory orders have so far not resulted in higher producer prices, indicating that the underlying price dynamic is still weak.
- Economic divergence continues in services and manufacturing.
- Inflation lifts its head and we expect annual inflation to reach 1.5% in 2021.
- ECB is likely to emphasize that the PEPP is flexible and that asset purchases are front-loaded.
- We do not expect the ECB to extend the PEPP beyond March 2022.
- No targets or exact measures of financial conditions are expected.
At the upcoming governing council meeting on Thursday, the ECB will publish its updated macroeconomic projections. They are likely to confirm the rather strong, albeit delayed, recovery. An update to the inflation forecast will be closely watched for both the estimated impact of temporary factors and longer-term dynamics. We think that ECB’s current inflation projections are too pessimistic, thus an upward revision is likely.
Despite the recent rise in government bond yields, the ECB is unlikely to drastically change its monetary policy at this point. There seem to be large differences in opinions in the governing council and there is no clear step to take at this point.
But there is a need for the ECB to clarify its stance on rising bond yields and open up how it actually measures financial conditions. We do not, however, expect the ECB to provide us with any exact measures and targets on what they perceive as easy financial conditions. So markets would need to continue speculating on this.
Some of the more hawkish governing council members have downplayed recent developments and have even seen these as signs of an economic recovery and positive inflationary developments. Nevertheless, the ECB is likely to reiterate that ultra-accommodative monetary policy is still needed and is ready to adjust its policies if necessary. It is also likely to emphasize the flexibility of its PEPP purchases as a tool to keep financing conditions from tightening, even if the purchases have not risen during the past weeks.
One thing to look out for is a possible verbal emphasis on front loading asset purchases – this would be justified given the ongoing weakness in the services sector and a likely strong activity rebound in the second half of this year. A front-loading of purchases is in line with our projections from December and could temporarily help to push down yields a bit, but there is a risk this is not enough for markets. However, in the most likely macroeconomic scenario, we do not see the extension of PEPP beyond March of 2022, since it is, after all, designed to be an emergency pandemic tool.
Nerijus Maciulis, firstname.lastname@example.org, +370 5 258 22 37
Heidi Schauman, email@example.com, +358 50 328 1229