As Europe’s economy continues to recover from COVID-19, it appears the central bank will remain accommodative, but for how long? Our Head of European Fixed Income David Zahn shares his views.
At its meeting on June 10, the European Central Bank (ECB) remained committed to supporting the market, confirming its very accommodative policy stance as the economy continues to recover from the pandemic. Marketwatchers were concerned that the tap might be turned off or reduced, but the ECB signaled it would continue to buy bonds under its €1,850 billion Pandemic Emergency Purchase Program (PEPP) “at least the end of March 2022 and, in any case, until it judges that the coronavirus crisis phase is over.”
Since the beginning of the year the ECB has stepped up the pace of its bond buying to around €80 billion per month over the past quarter and said it would continue to buy at an accelerated rate as conditions warrant.
The ECB also raised both its growth and inflation forecasts for this year. The growth forecast for this year was raised to 4.6%, up from its prior forecast in March of 4%. It also raised its inflation projections to 1.9% this year (just below its 2% target) up from its previous forecast of 1.2%.
The economic forecast has changed quite dramatically and reflects incredible growth for Europe. We are clearly seeing a strong rebound in Europe—but the magnitude of growth is likely to be more temporary in nature, so this could be the last policy meeting where we will see this type of accommodation. That means there will probably be more volatility in the markets over the next couple of quarters as there will be a battle between hawks and doves.
The ECB also said the risks are balanced to the economy, and I think that’s the first time it has used that language in a number of years—the ECB hasn’t generally been this optimistic. That said, I don’t think the central bank wants to make any major change before their strategic review at the end of the summer, where ECB policymakers review the state of economy, inflation and how they think about their inflation target, how they communicate to the public, and the monetary policy tools they have to achieve their goals, among other things.
As growth and inflation pick up, it certainly makes sense to think about removing some accommodation. That doesn’t mean bond yields will rise, but peripheral bond spreads are likely to widen. The reason they have been so tight is because of ECB buying, and if that support is reduced, it’s natural we will see some market shifts.