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EURUSD made a 1-month high around 1.2161 on broad weakness in the US dollar amid coordinated jawboning by both Yellen (U.S. Treasury Secretary) and Lagarde (ECB President) to stem the higher bond yields on both sides of the Atlantic. Lagarde said that the ECB is closely monitoring the evolution of long-term nominal bond yields and that it will continue to support all sectors of the economy by preserving favorable financing conditions over the pandemic period.
Lagarde said in a prepared virtual speech at the opening plenary session of the European Parliamentary Week:
Investing in our climate, social and economic resilience: What are the main policy priorities?
I would like to thank you warmly for inviting me to speak to you today. It is a privilege to have an opportunity to talk to the citizens’ representatives at the heart of European democracy. Events like this one allow us to consider national debates in discussions about our common challenges as Europeans.
For all of us, the past year of the pandemic has been an extraordinary challenge. And, at all levels, the public policy response has been truly impressive. National responses have spearheaded the policy effort, with fiscal measures amounting to, on average, 4.5% of euro area GDP.
Yet the response to this crisis stands out from previous ones in that the level of policy alignment achieved has been truly unprecedented. The strength of Europe’s crisis response has crucially depended on the strength of national and European responses across all areas: monetary, fiscal, supervisory, and regulatory.
But the pandemic is not over yet. Policy alignment will continue to be imperative for what lies ahead. So I would like to look at how our policies can keep reinforcing each other in addressing two common challenges: shielding the economy and subsequently transforming it.
Shielding the economy
While people are drawing hope from the start of vaccination campaigns, the first challenge – “shielding” – calls for us to continue to bridge the gap until widespread immunity is achieved. Across Europe, people are still grappling with the economic and social consequences of the pandemic. And it is still highly uncertain how the next stages of the pandemic will unfold.
In this context, our pandemic emergency purchase program (PEPP) has been tailored to the pandemic, helping to stabilize markets and ease our policy stance to support the recovery. It will continue to be a crucial tool. The PEPP envelope of €1.85 trillion gives us considerable firepower and flexibility in conducting purchases.
Moreover, our targeted longer-term refinancing operations will remain an attractive source of funding for banks, supporting the flow of credit to households and firms. SMEs tend to benefit disproportionately from abundant and cheap credit, and smaller firms have been able to borrow at the lowest rates ever recorded.
The ECB will continue to support all sectors of the economy by preserving favorable financing over the pandemic period, as it has done since the start of the crisis. This commitment implies looking at indicators along the whole transmission chain of our monetary policy – from risk-free rates to government borrowing costs to capital markets to bank lending for firms and households.
Within the broad-based set of indicators that we monitor to assess whether financing conditions are still favorable, risk-free overnight indexed swap (OIS) rates and sovereign yields are particularly important, because they are good early indicators of what happens at downstream stages of monetary policy transmission since banks use those yields as a reference when setting the price of their loans to households and firms. Accordingly, the ECB is closely monitoring the evolution of longer-term nominal bond yields.
The overall policy mix, however, remains essential. While the pandemic persists – and lockdowns and heightened uncertainty continue – firms and households will only be able to take full advantage of favorable financing conditions if national policy measures are deployed to help monetary policy unfold its full potential.
By continuing to take the lead in protecting the firms and sectors most exposed to the crisis, fiscal policy can help brighten economic prospects for firms and households, thereby strengthening monetary policy transmission. The ECB’s Consumer Expectations Survey demonstrates this: people who consider government support to be more adequate display less precautionary behavior. Those people are in turn more likely to respond to favorable financing conditions and increase their consumption.
In the euro area, the budget balance is expected to be -6.1% of GDP in 2021. With monetary and fiscal policies working in tandem, we hope that we will finally cross the bridge and reach the other side of the pandemic.
Transforming the economy
The second policy challenge will arise as the economy gradually reopens. And this second challenge will be quite a different one. It won’t be about returning to the pre-pandemic status quo. It will be about bringing the economy rapidly back to potential while using the thrust of the recovery to transform our economies.
The focus will then be on reducing the damage caused by the pandemic, such as permanent job reductions, which one in five firms are considering. At the same time, it will be crucial to harnessing the potential offered by the pandemic, which has spurred a multi-year leap in digital progress and has brought a new focus on sustainability. Digital and green technologies present massive possibilities for more vibrant, inclusive, and sustainable growth. In the energy sector alone, scaling up green investment to the necessary levels could create an estimated 1.1 million jobs across Europe by 2030.
Europe is leading the way in addressing this double policy challenge. Its Next-Generation EU (NGEU) recovery package is designed to support demand today and generate growth potential tomorrow through investment and reforms. Indeed, NGEU is expected to provide, on average, around 1% of GDP in grants and loans per year over the next three years, while committing 37% of funds to green investment, and 20% to digital.
Next to EU policies, national policy action will have to play a vital enabling role in smoothing the transition and promoting change. First, by ensuring that NGEU funds can be fully operational when the decisions on own resources are ratified in all Member States, which in many cases involves national parliaments.
And second, by creating the right economic environment to boost the impact of NGEU. This means improving the quality of government spending and ensuring that NGEU is firmly rooted in sound structural policies conceived and implemented at the national level. If used for productive public investment, NGEU funds could increase real output in the euro area by around 1.5% of GDP over the medium term. So there must be priority areas if we are to reform, modernize and come out of this crisis with renewed vigor.
Let me conclude by emphasizing that all of us, across all policy levels, must pull together to meet our shared challenges and ensure that Europe can emerge stronger from the pandemic.
In her last monetary policy presser (Q&A) on 21st Jan, Lagarde was asked about the Bank of Spain Governor’s suggestion for some form of YCC by the ECB officially rather than doing a de facto YCC to keeping borrowing costs at ultra-low (through pandemic QE). Lagarde said:
Let me just again restate what we are doing which, by definition, will tell you what we’re not doing. Our aim is to preserve favorable financing conditions in the euro area, and we want to do that because we believe that it will support consumer spending, it will support investment spending, and ultimately it will help achieve our mandate of price stability. And as I said, our assessment of favorable financing conditions is not driven by any single indicator. It is a holistic approach, it takes into account multiple indicators, and, you know, bank lending is one, credit conditions are one, corporate yields is one, sovereign bond yields is one, and it’s by combining all of those that we try to assess whether the financing conditions are favorable or not.
Now, obviously, government bonds yields play an important benchmark role in the pricing of credit in the economy. But at the moment we do not see that development in any particular yields poses an issue for euro-area-wide financing conditions. And that really, I think, my answer actually tackles your two questions. We’re not riveted to any particular yield. We take into account multiple indicators that relate to the financing of the economy, and as I said, we believe that financing conditions are currently broadly favorable based on that multifaceted, holistic assessment that we do of those very indicators that I have mentioned.
Lagarde said on Eurozone fiscal stimulus:
Concerning the fiscal stimulus, I would observe that both from a monetary point of view and from a fiscal point of view, it is necessary to continue to be accommodative. The situation is sufficiently uncertain that fiscal needs to be continued at the national and the European level for the region to; defeat the pandemic would be nice, but certainly to counter the downward impact of the pandemic on the growth of the economy, obviously on prices, and inflation. So, we believe that fiscal has to be continued.
The probably slight qualification that we would have, which I think is also in the introductory statement, is that we certainly recommend that it be made as targeted as possible, and temporary, given that we all hope that, thanks to those combined policies, we will see a recovery during the course of 2021, probably second half more than the first half, and then continuing throughout 2022.
But the fiscal policy has to continue being supportive of the economies. Let me also observe that combining the national efforts that have been undertaken, both in terms of discretionary additional fiscal support, and in terms of guarantees, which if, you know, put together, are in the range of 24 percent, roughly, of GDP, if you combine that, plus the threefold package that was approved initially in April, of, you know, the SURE program, the ESM program, and the EIB additional guarantee program, for a total of €540 billion, and the combination of the Recovery and Resilience Fund, and the MFF, the multiannual budget, you arrive at a global package which is significant.
And your question actually prompts me to once again to reiterate the fact that it needs to be rolled out. It has now been decided, it has been an extraordinary breakthrough for the Europeans at large, that there is this joint borrowing, but it needs to be rolled out promptly, and hopefully, we will see the disbursement in the course of 2021 in order to support some of the commitments that are made and some of the identified investments that are proposed by the countries.
So, it’s a question of the ratification process for the own resources, and a question of the recovery and resilience plans, which have to be submitted as well. But on the fiscal front, I think that nationally and regionally there is that joint effort, which is significant, which is there, for which there is a political will of 27 countries, which is always a bit of a challenge as opposed to when you have one fiscal authority and one single country as is the case in the US. And on that page, I would really want to take this opportunity to wish my colleague and friend, Janet Yellen, the very best in her endeavour to lead the US economy in the way that only she can do it, inclusively and very smartly.
Further on late Monday, ECB’s Villeroy said he doesn’t see the risk of overheating in the economy, while financing conditions expected to remain very accommodative, there is no risk of a lasting pickup in inflation.
Meanwhile, on Tuesday, data shows that the Eurozone core CPI jumped +1.4% in Jan from Dec’ +0.2%, well over the market expectations of +0.2% (y/y) and at the biggest increase since late 2015, mainly due to higher service cost and non-energy industrial goods. But the HICP core CPI, which ECB tracks, was unchanged at +1.4% in Jan due to factors related to German VAT reduction/reapplication (temporary).
Eurozone Core CPI
Eurozone Core CPI (Prices)
Overall, the Eurozone economy may be under a deflation/stagnant-like scenario even before COVID due to a decade of austerity (lack of fiscal stimulus) despite never-ending ECB monetary stimulus and ultra-low borrowing costs (almost ZIRP). The ECB/Lagarde is now taking the COVID adversity as a great opportunity, urging EU states to go for targeted fiscal bazooka and structural reforms to bring out the Eurozone economy from decades of deflation.
Eurozone GDP growth
The export-heavy Eurozone economy was already under slower economic growth around +1.3% on an average (y/y) since H2-2018, primarily due to the Trump trade war (U.S.-China/EU) and Brexit uncertainty. Now as both trade war as-well-as Brexit uncertainty is almost over (under Biden admin and Brexit deal), the Eurozone economy should grow by around +2.5% (pre-COVID levels) on an average after COVID; i.e. from mid-2022 or 2023 onwards. Trade deals with China, some other countries and expected fiscal/infra/green stimulus (NGEU) should help.
Although ECB is already doing de facto targeted YCC in various Eurozone member states as per evolving economic scenario, on 21st Jan, Lagarde said there were no worries about government bond yields and ECB is not targeting any particular levels of bund yields. But on 22nd Feb, Lagarde said the ECB is closely monitoring the evolution of longer-term nominal bond yields as banks generally use these bond yields as a reference to price their loans to corporates and households. The ECB will use the PEPP buying (pandemic QE) flexibility as the main tool to ensure overall ultra-accommodative /favorable financial conditions (apart from other tools-risk free OIS rate, corporate bond yields, and credit conditions).
Lagarde clearly said that the ECB will ensure COVID monetary vaccine (stimulus/PEPP & other tools) till at least Mar’22, when the EU is expected to achieve widespread herd immunity as the COVID mass-vaccinations may end by Dec’21. The ECB will have to ensure ultra-low borrowing costs (near zero) for not only Germany, France, Italy and Spain, but also for other fragile EU member states to fund COVID fiscal stimulus.
Technical outlook: EURUSD
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