ECB Strategy Has the PEPP Had Its Day?

The ECB has used quantitative easing aggressively in recent years to support the euro-area economy, banks and asset prices. It currently has in place two separate programs with quite different purposes:

The Asset Purchase Programme (APP), first introduced in 2014 and restarted in September 2019, aims to reinforce the ECB’s negative interest rates and help counter downside risks to price stability. The APP purchases €20 billion a month and is due to end “shortly before” the ECB starts raising interest rates.

The PEPP, launched in March 2020 to counter downside risks to the inflation path caused by the COVID-19 pandemic, differs from the APP in two important ways. First, the monthly purchase pace is flexible and secondary to the program’s main aim: preserving “favorable financing conditions.” To this end, the ECB raised the pace from €60 billion in the first quarter to €80 billion in the second and third quarters, and aims for a “moderately lower” pace in the fourth quarter. The second difference from the APP: the PEPP is meant to last only so long as the pandemic weighs on the inflation path.

What Will It Take to Wind Down the PEPP?

So, when will the ECB be able to conclude that the crisis phase is over?

Although the coronavirus delta variant has clouded the outlook somewhat, the economy has improved rapidly in recent months, and the ECB should have sufficient information by its December meeting to confirm that the PEPP will expire next March. Indeed, the central bank’s September forecasts suggest a fading need for emergency monetary stimulus:

  • The ECB expects the level of output to rebound to near its pre-pandemic path in coming quarters (Display below, left) and the output gap to close in 2023.
  • Core inflation is expected to reach 1.5% in 2023. That’s the same level as the ECB’s September 2019 forecast for 2021 core inflation, but the trajectory is very different—inflation is now rising instead of falling (Display, right).

But the economic revival doesn’t mean the ECB will cease its asset purchases altogether. With inflation still far from target, a rate hike is still several years away, so the ECB is likely to be buying bonds via the APP for some time to come.