October ECB meeting preview: Priming the pump

By Jeremy Hawkins, Senior European Economist
October 26, 2020

Despite rising speculation that another ease is not very far away, the market consensus is again for no change in policy at Thursday’s ECB announcement. However, in contrast to the September discussions the risk of a move this week is significantly higher.

No change would mean net purchases under the asset purchase programme (APP) remaining at an open-ended €20 billion/month, supplemented by the €120 billion temporary QE envelope due to end in December. It would also see the wholly separate pandemic emergency purchase programme (PEPP), currently scheduled to run through at least June 2021, being held at €1.35 trillion. At the same time, there is a strong consensus for no move on key interest rates which seem to have reached their lower bound (refi 0.00 percent, deposit minus 0.50 percent and marginal lending 0.25 percent).

If the ECB were to adjust policy, it would most likely be via the PEPP which, since its launch in March, has become the main weapon in the central bank’s QE arsenal. However, having peaked at just over €120 billion in June, net monthly purchases funded by the programme have dwindled and in August were less than €60 billion. While that is still a significant figure, it means that as of September, only €567.2 billion of the €1.35 trillion of available funds had been utilised. Consequently, even if the pace of QE asset purchases is stepped up there is unlikely to be any immediate pressure to expand the overall size of the programme and, indeed, it would probably prove politically difficult to do so anyway. As a result, there has also been talk of a possible increase in the APP, if only to offset the prospective loss of the current emergency envelope that expires in December. Importantly, previous concerns about the constraints on prospective bond purchases imposed by the capital key have been eased by the increased supply of bonds from national governments used to finance their fiscal support packages.

The reduction in PEPP purchases has reflected the absence of any significant strains in local financial markets. Indeed, the entire Eurozone yield curve has fallen further below zero since the September ECB meeting and, crucially from a policy perspective, government bond spreads across the region have continued to narrow. The ongoing improvement in financial stability allowed yields in some Eurozone peripherals, notably Greece, to hit new record lows earlier this month. Amongst this group, Italy (19 percent) and Spain (12 percent) continue to benefit disproportionately from PEPP buying.

However, while the financial markets might have been behaving themselves, recent economic news has been much more mixed and, ultimately, indicative of a sharp deceleration in the speed of the recovery. On the positive side, consumer demand has bounced back surprisingly quickly despite historically weak confidence and retail sales in August were comfortably above their pre-lockdown level. In the same vein, at 8.1 percent, the unemployment rate in the same month was still relatively low and only 0.6 percentage points higher than a year ago. By contrast though, growth of output has cooled significantly and August industrial production was still almost 6 percent below its February mark. Moreover, the flash October PMI survey warned of a soft start by manufacturing to the current quarter and an even weaker performance by services. The latest inflation developments will hardly put a smile on the ECB’s face either. September’s headline rate dropped further below zero to minus 0.3 percent, its lowest reading since January 2015. Even worse, the narrow core rate decreased to just 0.2 percent, a new record low. Both gauges have been biased down by cuts in German and Irish VAT rates but underlying weakness is clear enough.

Ominously, the economic recovery was already running out of steam before the latest surge in new Covid-19 cases. With record daily rates of infection in many Eurozone countries, governments have been forced to introduce fresh containment measures that will inevitably exacerbate the current slowdown. At this stage, all member states have avoided total nationwide lockdowns but if the latest restrictions do not work, the so-called “nuclear option” might be the only choice left. Third quarter Eurozone GDP growth will still be a record but, on current trends, the fourth quarter could even carry a negative handle.

Against this background, some Governing Council members will probably look at the economic fundamentals and prefer to act sooner rather than later, especially since ongoing squabbles over the EU Commission’s €672.5 billion Recovery and Resilience Facility (RRF) are threatening to delay some much-needed help from fiscal policy. However, the more hawkish members will no doubt emphasise the stability of the financial markets and demand updated economic forecasts before agreeing to any additional stimulus. New projections will be available at the last meeting of the year making the 10th December the more likely date for any policy shift. Nonetheless, at the very least expect ECB President Lagarde’s press conference to do some serious pump priming.