Lagarde prepares to relaunch the ECB’s economic stimulus efforts

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When Christine Lagarde announces the European Central Bank’s latest policy decision on Thursday, she will have a simple message for eurozone governments and banks: don’t worry about rising debt levels, borrowing costs will stay. low for a very long time.

Ms Lagarde and other ECB policymakers have signaled in recent weeks that they are very likely to increase central bank stimulus measures in a bid to mitigate the lingering economic damage caused by the coronavirus pandemic.

The measures should include an expansion of the ECB’s main crisis-fighting tools by buying more bonds for a longer period, while financing banks at very negative interest rates as long as they keep credit in line. circulation.

The increase in debt is vital to support the economy hit by the pandemic, said Lagarde.

Some investors believe that the widening of the stimulus package means that the ECB has adopted an informal strategy of ‘yield curve control’ – aimed at keeping sovereign bond yields at a certain level to cap borrowing costs up to ” The economy bounces back and inflation hits its target of near, but below, 2 percent.

Ms Lagarde stopped short of openly committing to such a strategy, as the Bank of Japan and the Reserve Bank of Australia have done, but she promised last month that “funding terms will remain exceptionally favorable for as long as necessary ”.

This leaves ECB watchers with four main areas to watch.

Infinite QE

As the virus takes hold across Europe this spring, the ECB has launched a new quantitative easing effort, the Pandemic Emergency Purchase Program (PEPP), with the aim of buying up ‘to 1.35 billion euros in bonds.

It is expected to run through June but, faced with the new wave of coronavirus infections and restrictions in recent weeks, the ECB is likely to expand its size and timing.

There is still 600 billion euros to be spent initially; most economists expect the ECB to add at least another 500 billion euros and extend the PEPP until the end of 2021. Many believe it could go further, until June 2022.

That would be enough for the ECB to buy 70% of all bonds issued by governments in the euro area next year, and 150% of net issuance after buybacks, according to Frederik Ducrozet, strategist at Pictet Wealth Management.

“The ECB doesn’t want to say it out loud, but it effectively controls yields and spreads,” said Richard Barwell, head of macro research at BNP Paribas Asset Management. “They are essentially running out of ammunition and are relying on good luck and good fiscal policy to turn around demand, even though they may continue to push up asset prices.”

A more important question is how the ECB will decide on the end of the pandemic crisis. Isabel Schnabel, a member of the ECB’s board, said this month that “the economic crisis will take longer than the health crisis” – indicating that the ECB will likely continue to buy bonds long after enough people will have been vaccinated to overcome the pandemic.

A bigger boost for banks

Lending money to banks at extremely low rates to encourage them to keep credit flowing is the ECB’s other main crisis response tool. Its Targeted Longer-Term Refinancing Operations (TLTROs) have loaned banks nearly € 1.5 billion at rates as low as minus 1% if they maintain lending levels.

The program is due to expire in March and the ECB has indicated it will likely be extended. It is less clear whether the rate will be lowered further into negative territory. Krishna Guha, vice president of Evercore ISI, said the ECB could introduce “an additional hyper-concessional rate” for banks that increase lending to small businesses.

Few economists expect the ECB to lower its overall deposit rate by minus 0.5 percent. But doubts remain as to whether this will increase the exemption for lenders on the negative interest they pay on central bank deposits. This exemption is set at six times a bank’s reserve requirement, but ABN Amro’s Nick Kounis predicted it would rise to eight times after banks’ excess deposits jumped € 1.8 billion to € 3 billion. , 3 billion euros.

Darker perspectives

With coronavirus vaccines set to be approved and delivered across Europe, one would expect the ECB to adopt a sunnier outlook in its latest economic forecast.

But the likelihood of a slowdown in the fourth quarter means that most economists expect it to lower its growth outlook for next year, even if that is offset by a more optimistic outlook for 2022 and 2023.

A vital question will be whether the ECB will lower its inflation forecast and to what extent it expects price growth to be below target by 2023.

Euro strength

In recent weeks, the euro has climbed above $ 1.21, its highest level since 2018. If this mainly reflects a weaker US dollar, this is a concern for the ECB, as a stronger euro exerts downward pressure on inflation by lowering import prices.

A stronger euro “cancels out almost all of the reflationary benefits of national and planned joint fiscal measures in response to the pandemic this year,” according to Lena Komileva, chief economist at G + Economics.

Ms Lagarde said the ECB was monitoring the exchange rate; it could express its additional concerns about the economic consequences of the persistence of this high level.

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