Dhe European Central Bank (ECB) announced on Thursday that its crisis program PEPP would be increased by a further 600 billion to 1.35 trillion euros. That was another 100 billion euros more than most observers had expected. In addition, the program is to be extended to at least June 2021. The central bank plans to reinvest the amounts from expiring bonds at least until the end of 2022. The central bank, however, left the base rate and deposit rate unchanged.
The announcement that the program would be increased has at least temporarily had a positive impact on the financial markets. The German stock index Dax, which had not yet been impressed by the Federal Government’s economic stimulus package on Thursday morning – especially auto stocks even declined because there was no scrapping premium – rose in response to the ECB decision. Later, however, he gave up the profits again and shortly before the market closed 0.5 percent in minus at 12423 points. Italian government bonds were in demand on the bond market; the yield on ten-year bonds fell significantly, at times to 1.39 percent. The euro rose against the dollar.
ECB President Christine Lagarde justified the move with the severity of the shock caused by the corona crisis. There was unanimity in the Governing Council that action should be taken – even if the extent of the increase in the program had been discussed.
Less growth, less inflation
The central bank further lowered its projections for the development of the economy and inflation. Your baseline scenario now predicts a 8.7 percent drop in gross domestic product this year. Back in March, the ECB economists had thought growth of at least 0.8 percent was possible. The central bank now anticipates a recovery of 5.2 percent in 2021 and growth of 3.3 percent in 2022.
“The latest indicators point to some bottoming of the May downturn as parts of the economy are gradually reopening,” said Lagarde. Accordingly, the economy is expected to pick up again from the second half of the year. “However, the speed and extent of the recovery remain extremely uncertain.”
The central bank also lowered its forecasts for inflation. Inflation in the euro area fell to 0.1 percent in May. The central bank now expects only 0.3 percent this year; So far, it had assumed 1.1 percent. But even for the end of its forecast horizon in 2022, the European central bank now sees inflation at only 1.3 percent. By contrast, the medium-term target is inflation of “below, but close to 2 percent,” as Lagarde once again emphasized. One hopes to be able to return to the “pre-crisis inflation path” by increasing the crisis program.
The ECB President emphasized that the PEPP crisis program could be used flexibly and, for example, that corporate bonds would also be bought – in addition, the distribution to the various euro countries would be handled flexibly, and that for the entire life of PEPP. This was interpreted as a sign that the central bank does not want to stick rigidly to the capital key that had regulated the distribution among the euro countries in previous bond purchase programs.
Wasn’t that all?
On the critical judgment of the Federal Constitutional Court on bond purchases, Lagarde went little beyond what ECB board member Isabel Schnabel had recently said in interviews. The central bank is under the jurisdiction of the European Court of Justice and has declared the PSPP bond purchase program to be legal, said Lagarde. The Karlsruhe ruling is aimed at the German federal government and the Bundestag.
“We are confident that a good solution will be found that does not in any way question the independence of the ECB and the primacy of European law.” Lagarde assured that the Governing Council’s decisions are constantly assessing the costs and consequences of its decisions, as the Court of Justice does demanded – this was also the case now when deciding to expand the crisis program. The cost-benefit analysis will be found in the central bank’s minutes when they are published.
The reactions of economists were very different. The ECB shows once again that it has recognized the seriousness of the situation, said Holger Schmieding, chief economist at Berenberg bank. “As it has done several times before, it even slightly exceeded expectations.” Volker Wieland, on the other hand, said that such a substantial increase was not absolutely necessary. An important factor in the decision was, among other things, the emphasis on the flexible implementation of the crisis program, said economics professor Jan Pieter Krahnen.
Jörg Krämer, chief economist at Commerzbank, said that he saw his opinion confirmed that the ECB should continue to relax its monetary policy in the future. The market received the package overall positively, said Konstantin Veit from bond investor Pimco. Italian government bond yield spreads against Germany would have narrowed by around 15 basis points. All in all, it was a “fairly moderate market movement”.