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EURUSD almost flat as ECB just recalibrated PEPP/QE buying pace instead of any tapering

calendar 09/09/2021 - 21:45 UTC

Overall, ECB purchased around €80B/M PEPP on an average from Mar’21 to July’21 to combat Delta variants and in August’21, the net purchase was reduced to around €65B. In CY20, the average monthly rate of PEPP was around €76B/M, which was reduced to an average €56B/M during Jan-Feb’21. Looking ahead, as per ECB sources (post-meeting as usual), it will buy between €60-70B; i.e. ~€65B worth of assets/bonds under PEPP on an average till at least Dec’21 in a flexible manner.

In CY20, the total QE (APP+PEPP) per month was around €90.552B on an average against CY21 figure of €90.816B/M (till August’21). Till Aug’21, ECB’s cumulative PEPP purchase was €1337.24B against a total envelope of €1850.00B (till Mar’22); i.e. ECB has to purchase assets around €512.76 from Sep’21 to Mar’22 with an average run rate of €73.25B/m. This average is close to the ECB source of around €65.00B/M. ECB will use its flexibility to purchase above or below this indicated amount as per evolving economic situation.

In brief, ECB will buy total QE assets (APP+PEPP) at an average monthly rate around €85.00-93.251B as per ECB source and above calculation, which is very near to the CY20 average of €90B/M. ECB will decide PEPP in Dec’21 meeting as the scheduled expiry date (Mar’21) is approaching.

Thus ECB has just adjusted the PEPP buying pace from an earlier (Mar-July’21) high to normal mode and it’s not a QE tapering at all; it’s just another ‘recalibration’. In her presser, ECB President Lagarde also clarified that ECB is not tapering, but recalibrating PEPP (from Apr-July’21 higher rate) to moderately lower (normal) rate for the next few months under the current economic situation, which is much more stable than earlier months of the year amid the rapid pace of herd immunity (COVID vaccinations).

ECB QE (APP+PEPP) summary:

In Euro Area 19 member states (countries), all are not strong economies like Germany, Belgium, Netherlands, or Austria. Even France, Italy, and Spain have a quite fragile economy, running structurally high debt compared to the EU Gold standard. Moreover, peripheral economies like Greece, Portugal are quite fragile. Thus, ECB has to ensure lower borrowing costs for these fragile economies in years to come by keeping inflation, interest rates and bond yields lower.

The ECB is also open to extending the PEPP beyond Mar’22 until the Governing Council (GC) judges that the coronavirus crisis phase is over and there is substantial progress of ECB’s single mandate of price stability (inflation on a durable basis). At the current trend of core inflation rate (y/y), the ECB will never be ‘able’ to achieve the ever-elusive target of 2% (y/y) and thus will be at present lower bound until at least 2025 or forever!

ECB is not been ‘satisfied’ with consistent inflation ‘misses’ over a decade and its policy credibility is also now at stake. The ECB was never able to stimulate the economy even by its perpetual ultra-accommodative monetary policy due to lack of adequate fiscal stimulus. Thus ECB miserably ‘failed’ to achieve its inflation target and was never able to hike (normalize) after the 2008 GFC due to the fiscal austerity policy of many EU member states and lack of common fiscal authority.

Now ECB is urging EU member states to take necessary steps for implementation of the common EU Next Generation fiscal/infra stimulus (NGU) immediately, while various EU member states are still divided on the same. This lack of common fiscal authority despite a common currency (EUR) and common monetary authority (ECB) may be the main reason behind EU inequality and fragmentation.

The ECB’s current policy of back-door YCC through targeted PEPP (bond-buying) may also accelerate the ‘Japanification’ of the Eurozone economy, making EUR like Japanese Yen- more like funding rather than growth currency. Like Fed, the ECB is also ensuring EU borrowing costs at ultra-low levels to fund NGU; and for that ECB may not taper PEPP even in Mar’22 and replace it with another QE.

After the 2008 GFC, ECB was several years behind Fed in QE tapering and this time, it may be the same. The ECB has practically no weapon left except targeted PEPP (backdoor YCC) and ‘powerful’ forward guidance (jawboning) in keeping EU bund yields lower, especially on the peripheral areas; ECB was at almost ZIRP since 2008 GFC and can’t cut lending (repo) rates below zero. The policy divergence between ECB and Fed/BOE is making EUR lower, but as an export-heavy economy, the EU also needs weaker currency, irrespective of ECB and inflation narrative. Looking ahead, ECB may be more comfortable to keep EURUSD around between 1.20-1.10 rather than 1.20-1.30.

Officially, as Eurozone inflation is running consistently far below the +2.0% target, ECB never tried to hike rates after the 2008-10 GFC and 2013 debt crisis. Going forward, ECB’s latest inflation projection (+1.5% by 2023) also shows that ECB may also be never able or have any intention to hike rates (normalization) but may go for QE (PEPP) tapering from Dec’22 or Mar’23 after Fed completes its QE tapering by Sep’22 and goes for liftoff from Dec’22 (as expected).

ECB policy rates and economic projections:

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ECB Statement: Full text

Monetary policy decisions: 9 September 2021

Based on a joint assessment of financing conditions and the inflation outlook, the Governing Council judges that favourable financing conditions can be maintained with a moderately lower pace of net asset purchases under the pandemic emergency purchase programme (PEPP) than in the previous two quarters.

The Governing Council also confirmed its other measures, namely the level of the key ECB interest rates, its forward guidance on their likely future evolution, its purchases under the asset purchase programme (APP), its reinvestment policies, and its longer-term refinancing operations. Specifically:

Key ECB interest rates

The interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.00%, 0.25%, and -0.50% respectively.

In support of its symmetric two percent inflation target and in line with its monetary policy strategy, the Governing Council expects the key ECB interest rates to remain at their present or lower levels until it sees inflation reaching two percent well ahead of the end of its projection horizon and durably for the rest of the projection horizon, and it judges that realized progress in underlying inflation is sufficiently advanced to be consistent with inflation stabilizing at two percent over the medium term. This may also imply a transitory period in which inflation is moderately above target.

Asset purchase programme (APP)

Net purchases under the APP will continue at a monthly pace of €20 billion. The Governing Council continues to expect monthly net asset purchases under the APP to run for as long as necessary to reinforce the accommodative impact of its policy rates, and to end shortly before it starts raising the key ECB interest rates.

The Governing Council also intends to continue reinvesting, in full, the principal payments from maturing securities purchased under the APP for an extended period of time past the date when it starts raising the key ECB interest rates, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.

Pandemic emergency purchase program (PEPP)

The Governing Council will continue to conduct net asset purchases under the PEPP with a total envelope of €1,850 billion until at least the end of March 2022 and, in any case, until it judges that the coronavirus crisis phase is over.

Based on a joint assessment of financing conditions and the inflation outlook; the Governing Council judges that favourable financing conditions can be maintained with a moderately lower pace of net asset purchases under the PEPP than in the previous two quarters.

The Governing Council will purchase flexibly according to market conditions and with a view to preventing a tightening of financing conditions that is inconsistent with countering the downward impact of the pandemic on the projected path of inflation. In addition, the flexibility of purchases over time, across asset classes, and among jurisdictions will continue to support the smooth transmission of monetary policy. If favorable financing conditions can be maintained with asset purchase flows that do not exhaust the envelope over the net purchase horizon of the PEPP, the envelope need not be used in full. Equally, the envelope can be recalibrated if required to maintain favorable financing conditions to help counter the negative pandemic shock to the path of inflation.

The Governing Council will continue to reinvest the principal payments from maturing securities purchased under the PEPP until at least the end of 2023. In any case, the future roll-off of the PEPP portfolio will be managed to avoid interference with the appropriate monetary policy stance.

Refinancing operations

The Governing Council will continue to provide ample liquidity through its refinancing operations. In particular, the third series of targeted longer-term refinancing operations (TLTRO III) remains an attractive source of funding for banks, supporting bank lending to firms and households.

The Governing Council stands ready to adjust all of its instruments, as appropriate, to ensure that inflation stabilizes at its two percent target over the medium term.

MONETARY POLICY STATEMENT: PRESS CONFERENCE

Christine Lagarde, President of the ECB,

Luis de Guindos, Vice-President of the ECB

Good afternoon, the Vice-President and I welcome you to our press conference.

The rebound phase in the recovery of the euro area economy is increasingly advanced. Output is expected to exceed its pre-pandemic level by the end of the year. With more than 70 percent of European adults fully vaccinated, the economy has largely reopened, allowing consumers to spend more and companies to increase production. While rising immunity to the coronavirus means that the impact of the pandemic is now less severe, the global spread of the Delta variant could yet delay the full reopening of the economy. The current increase in inflation is expected to be largely temporary and underlying price pressures are building up only slowly. The inflation outlook in our new staff projections has been revised slightly upwards, but in the medium-term inflation is foreseen to remain well below our two percent target.

Financing conditions for firms, households, and the public sector have remained favorable since our previous quarterly assessment in June. Favorable financing conditions are essential for the economy to continue its recovery and to offset the negative impact of the pandemic on inflation.

Based on a joint assessment of financing conditions and the inflation outlook, the Governing Council judges that favourable financing conditions can be maintained with a moderately lower pace of net asset purchases under the pandemic emergency purchase programme (PEPP) than in the previous two quarters.

We also confirmed our other measures, namely the level of the key ECB interest rates, our forward guidance on their likely future evolution, our purchases under the asset purchase program (APP), our reinvestment policies and our longer-term refinancing operations, as detailed in the press release published at 13:45 today. We stand ready to adjust all of our instruments, as appropriate, to ensure that inflation stabilizes at our two percent target over the medium term.

I will now outline in more detail how we see the economy and inflation developing, and then talk about our assessment of financial and monetary conditions.

Economic activity

The economy rebounded by 2.2 percent in the second quarter of the year, which was more than expected. It is on track for strong growth in the third quarter. The recovery builds on the success of the vaccination campaigns in Europe, which have allowed a significant reopening of the economy.

With the lifting of restrictions, the services sector is benefiting from people returning to shops and restaurants and from the rebound in travel and tourism. Manufacturing is performing strongly, even though production continues to be held back by shortages of materials and equipment. The spread of the Delta variant has so far not required lockdown measures to be reimposed. But it could slow the recovery in global trade and the full reopening of the economy.

Consumer spending is increasing, although consumers remain somewhat cautious in the light of the pandemic developments. The labor market is also improving rapidly, which holds out the prospect of higher incomes and greater spending. Unemployment is declining and the number of people in job retention schemes has fallen by about 28 million from the peak last year. The recovery in domestic and global demand is further boosting optimism among firms, which is supporting business investment.

At the same time, there remains some way to go before the damage to the economy caused by the pandemic is overcome. There are still more than two million fewer people employed than before the pandemic, especially among the younger and lower-skilled. The number of workers in job retention schemes also remains substantial.

To support the recovery, ambitious, targeted, and coordinated fiscal policy should continue to complement monetary policy. In particular, the Next Generation EU programme will help ensure a stronger and uniform recovery across euro area countries. It will also accelerate the green and digital transitions, support structural reforms and lift long-term growth.

We expect the economy to rebound firmly over the medium term. Our new staff projections foresee annual real GDP growth at 5.0 percent in 2021, 4.6 percent in 2022 and 2.1 percent in 2023. Compared with our June staff projections, the outlook has improved for 2021 and is broadly unchanged for 2022 and 2023.

Inflation

Inflation increased to 3.0 percent in August. We expect inflation to rise further this autumn but to decline next year. This temporary upswing in inflation mainly reflects the strong increase in oil prices since around the middle of last year, the reversal of the temporary VAT reduction in Germany, delayed summer sales in 2020 and cost pressures that stem from temporary shortages of materials and equipment. In the course of 2022, these factors should ease or will fall out of the year-on-year inflation calculation.

Underlying inflation pressures have edged up. As the economy recovers further and is supported by our monetary policy measures, we expect underlying inflation to rise over the medium term. This increase is expected to be only gradual, since it will take time for the economy to return to operating at full capacity, and therefore wages are expected to grow only moderately. Measures of longer-term inflation expectations have continued to increase, but these remain some distance from our two percent target.

The new staff projections foresee annual inflation at 2.2 percent in 2021, 1.7 percent in 2022 and 1.5 percent in 2023, being revised up compared with the previous projections in June. Inflation excluding food and energy price inflation is projected to average 1.3 percent in 2021, 1.4 percent in 2022 and 1.5 percent in 2023, also being revised up from the June projections.

Risk assessment

We see the risks to the economic outlook as broadly balanced. Economic activity could outperform our expectations if consumers become more confident and save less than currently expected. A faster improvement in the pandemic situation could also lead to a stronger expansion than currently envisaged. If supply bottlenecks last longer and feed through into higher than anticipated wage rises, price pressures could be more persistent. At the same time, the economic outlook could deteriorate if the pandemic worsens, which could delay the further reopening of the economy, or if supply shortages turn out to be more persistent than currently expected and hold back production.

Financial and monetary conditions

The recovery of growth and inflation still depends on favorable financing conditions for all sectors of the economy. Market interest rates have eased over the summer but reversed recently. Overall, financing conditions for the economy remain favorable.

Bank lending rates for firms and households are at historically low levels. Lending to households is holding up, especially for house purchases. The somewhat slower growth of lending to firms is mainly due to the fact that firms are still well funded because they borrowed heavily in the first wave of the pandemic. They have high cash holdings and are increasingly retaining earnings, which reduces the need for external funding. For larger firms, issuing bonds is an attractive alternative to bank loans. Solid bank balance sheets continue to ensure that sufficient credit is available.

However, many firms and households have taken on more debt during the pandemic. A deterioration in the economic outlook could threaten their financial health. This, in turn, would worsen the quality of banks’ balance sheets. Policy support remains essential to prevent balance sheet strains and tightening financing conditions from reinforcing each other.

Conclusion

Summing up, the euro area economy is clearly rebounding. However, the speed of the recovery continues to depend on the course of the pandemic and progress with vaccinations. The current rise in inflation is expected to be largely temporary and underlying price pressures will build up only gradually. The slight improvement in the medium-term inflation outlook and the current level of financing conditions allow favorable financing conditions to be maintained with a moderately lower pace of net asset purchases under the PEPP. Our policy measures, including our revised forward guidance on the key ECB interest rates, are key to helping the economy shift to a sustained recovery and, ultimately, to bringing inflation to our two percent target.

Technical outlook: EURUSD

Technically, whatever may be the narrative, EURUSD now has to sustain over 1.19200-1.19800/1.20000 for a fresh rally towards 1.20600-1.22700/1.23000; otherwise may correct again towards 1.17000/1.16600-1.16000-1.13900.

 

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