Lagarde presser indicates ECB may extend PEPP in some other form beyond Mar’22

calendar 10/09/2021 - 20:55 UTC

The fine print of ECB President Lagarde’s August monetary policy statement and subsequent presser (Q&A) indicates that ECB may extend PEPP in some other form beyond Mar’22 and may go for PEPP tapering by Dec’22. Further ECB’s inflation projections indicate it may not go for any liftoff (gradual rate hikes) at least till Dec’25, while it will continue its asset-buying under APP or some modified form of APP beyond Dec’22 to at least Dec’25. Lagarde almost said that ECB will discuss details about the terms & conditions of PEPP (after Mar’22?) in the Dec’21 meeting.

Highlights of ECB President Lagarde’s August monetary policy statement, and Q&A session:

·         ECB will reduce the monthly buying pace of PEPP moderately lower than in the previous two quarters as ECB judges that favorable financing conditions can be maintained even with such a reduced asset-buying pace. Lagarde clarified that such moderately reduced buying of assets under PEPP is just a recalibration till Dec’21 (amid improving economic outlook) rather than a QE tapering; ECB is just moderately reducing buying pace of PEPP from higher levels in the last few months:


“I would preface my response to your first question by a quote, actually, in a way, which is, the lady isn’t tapering. Because what we are doing is recalibrating PEPP, which I’ll remind you is the Pandemic Emergency Purchase Programme, and we are recalibrating just as we did back in December and back in March. We are doing that on the basis of the framework, which is a joint assessment, so we look at the financing conditions, and we concluded that they remain favorable, and we do that on the basis of the inflation outlook.


And as you rightly pointed out, our inflation outlook has been upgraded, and it has been the case for ’21, significantly, ’22, quite significantly, and to a lesser extent, ’23. But across the board, you have an improvement on the inflation numbers for the whole horizon that we look at. We also look at other indicators, and on those accounts as well, there has been a significant improvement of the inflation numbers, both for ’22 and ’23.


So, on the basis of that joint assessment, and because we know that we need to keep favorable financing conditions, this is the commitment that we have and this is what we agreed in December. That hasn’t varied. We believe that we can maintain those favorable financing conditions with a moderately lower pace of purchase, and, of course, the choice of words is relevant. It is moderately lower than what we have done in Q2 and Q3.


Are we confident enough? Well, you know, the September meeting is conducted in the light of our projections, and what we are seeing is clearly an improvement on many fronts. The output numbers are much higher. The inflation numbers have been upgraded as I’ve just indicated. The employment numbers have also improved and the unemployment situation is serious, of course, but more benign than was anticipated.


So, on the basis of all that, and the success of the vaccination campaign, which we have all along said was critically important to determine the economic recovery, we believe that the euro area economy is rebounding. And that gives us the confidence to take the measure that we have taken, which, as I said, is a recalibration of our Pandemic Emergency Purchase Programme for the next three months.


·         ECB is not discussing the ‘next step’ of PEPP right now; it will discuss the same in the Dec’21 meeting as the scheduled expiry of the current PEPP is Mar’21. ECB will end the PEPP when it will feel confident about sustainable economic recovery and financing conditions are favorable to achieve the inflation outlook target; right now the underlying economic situation is not there:


“On the commitment for favourable financing conditions, I’ll remind you that that was decided at our Governing Council meeting in December, under the auspices of the PEPP. So PEPP is an emergency program, very specifically designed for the circumstances that we have been facing, that we still face today, but that is currently clearly improving. And this commitment to the favourable financing conditions is one of the two parts of the joint assessment that we conduct to determine our pace of purchase.


So, we have a framework that is very clearly designed and that operates in relation to PEPP. The day when PEPP is over will presumably indicate that financing conditions are favourable, and that the economy will have recovered in such a way that the downward impact of the pandemic on our inflation outlook has been resorbed.


At that point in time, the job is not finished, because we are still targeting our 2 per cent, which is now clear and straightforward, as a result of our strategy review. Symmetric 2 percent, in the medium term, with a special focus resulting from the lower bound.


So, that will continue, and the driver of our work going forward after PEPP will indeed be the mandate that we have to maintain price stability, as measured by our target of 2 percent inflation.


What we have done today, with the Governing Council members, unanimously, is to calibrate our pace of purchases in order to continue to deliver on our goal of favourable financing conditions. We have not discussed what comes next, and this is something for which we will prepare in the months to come, and I think there will be more interesting matters that will be debated in December, and of which, clearly, you will be informed in due course.


Now, concerning PEPP, you know, that’s a discussion that we will address comprehensively at our December meeting. As the term of PEPP approaches, we need to obviously discuss the terms and conditions of how that term occurs, and you will hear me again on this matter, certainly at our December meeting.”


·         ECB is concerned about elevated inflation, affecting the common public. But ECB thinks that this is purely transitory because of lower base effects, supply chain disruption/supply bottlenecks, higher pent-up demand & lower production/supply, the reimposition of German VAT/carbon tax; advanced summer sales, higher energy/oil prices etc. But ECB is confident that there will be no meaningful wage inflation; i.e. hikes in wages which may cause more persistent inflation. Thus ECB forecasted relatively higher inflation for 2021-22 and lower for 2023. ECB has forecasted HICP inflation at +2.2% for 2021, +1.7% for 2022 and +1.5% for 2023; core HICP inflation at +1.3% for 2021, +1.4% for 2022 and +1.5% for 2023:

I’m going to take advantage of that one to say a few words about inflation and how we conducted our discussion on inflation because it is a case that in many countries in the euro area, people are seeing prices increase and they can feel it. So we have to really go under the skin of inflation before we actually assess whether it is temporary, whether it is going to last. And that leads us to the conclusion of our inflation outlook, which, as you know, is 1.5 at the end of the projection horizon.

So what do we have at the moment? We have essentially three factors that are driving prices up. The first set of factors has to do with the reopening of the economy. I mean, this is the entire dynamic. It went down massively, and prices by the way at the time also went down. The economy reopened and, from a supply point of view, from a demand point of view, of course, there is pressure on prices.

You can see that in what we call the base effects, a lot has to do with energy prices, which constitute a large component of these base effects on inflation, And you can see that in the German value-added tax (VAT) impact, which obviously will continue to play out until the end of the year. You see that in the carbon tax that was decided also in Germany. So, those are the base effects, reopening of the economy-related factors.

As part of those reopening-of-the-economy factors, I would emphasize the supply bottlenecks effect, and this is something that the corporates and the companies are telling us, or telling you. There are bottleneck effects and not just in the semiconductor business, but in all sorts of sectors. These sectors are more or less affected; depending on how much they rely on either raw materials, or equipment, and where they get their supply from. And this is impacting durable and non-durable goods.

Now, how strong will that effect be, how long will it last, is something that obviously remains to be seen. We have put that particular item - if you remember the monetary policy statement that I read for you - we have put that in the inflation analysis, where we say that if those supply bottlenecks last longer than expected, then it will increase prices and will have an upside pressure. But we’re not certain, because typically what we have seen in previous situations of that nature is that when you have a bottleneck in your supply, you try to find alternatives to that supply.


And as a result of that, the supply bottleneck impact on inflation is reduced and eventually goes away. In the same vein, if it’s bottleneck inflation that applies without too much effect on the demand front, it’s not necessarily conducive to second-round effects on wages in particular. So, that’s the second one [set of inflationary factors], which is a subset of the reopening-of-the-economy consequences.


The third one, which is quite interesting as well, especially when you disaggregate it, is the inflation that is related to services, because we have seen a reopening of the economy on the service front, in the most recent months. And when you analyze where the inflation is in that segment of services, you see that most of it are actually coming from what was subject to social distancing and what obviously has been reactivated most recently.


So, those are the three key drivers of inflation at the moment. But, as you can see, many of them are of a temporary nature, and will last for a period of time, and will then either fall out of the period of reference, or will fade out over the course of time.


One component that we are addressing, monitoring, and checking very attentively is the second-round effect, is the impact that price increases will have on wage negotiations, and that is what could actually fuel a more persistent and durable price increase and inflation going forward. On that wages front, we are not seeing much by way of a significant increase. We will be very attentive to the autumn negotiations that are typically taking place in some countries. But at this point in time, we don’t expect these wage increases and these wage negotiations to be very strong and we see probably a gradual and moderate [wage] increase as a result of that. So, that’s what I really wanted to try to explain to you in response to your question about inflation.”


·         ECB has projected real GDP growth +5.0% for 2021, +4.6% for 2022 and +2.1% for 2023, but some private economists/analysts are quite concerned about 2022 GDP growth. Lagarde said ECB compared its staff projections with other global institutions like IMF, OECD, World Bank, etc, not with individual private forecasters. In any way, ECB is confident about the progress of economic growth amid the rapid pace of COVID vaccinations, reopening of the economy and restoration of the supply chain. ECB believes that the Eurozone economy will be back to pre-COVID levels (2019 GDP) by Dec’21, earlier than two quarters than previously expected, although there will be still significant slack in the labor market and production side. Looking ahead all will depend upon the COVID curve; if there is another big wave and lockdowns, the economy will again suffer:

“Well, on your first question about how confident we are, I observed that, since the beginning of the year, we have regularly upgraded our forecast. If anything, we might have been on the too pessimistic side, to begin with. And what I look at more - more so than analysts’ notes, which I’m attentive to, of course - is the projections that are produced by staff, how they compare with projections that are produced by other international institutions, such as the International Monetary Fund (IMF), the Organization for Economic Co-operation and Development (OECD), and other similar institutions.

We believe that the economy is going to continue to benefit from further unwinding of containment measures during the second half of ’21, into ’22 as well. We also make the assumption that bottlenecks will be circumvented by the economic operators in the first half of ’22. We believe that we will be back to the pre-pandemic, 2019 level at the end of this year, which is two quarters earlier than we had initially anticipated. And while we still have a lot of slack, both in production and in unemployment, we are also seeing that slack being resolved and reduced more rapidly than we had anticipated. So, that gives us good reasons to believe that ’22 is going to be another good, solid year.

We have not upgraded our forecast for ’22--- We still are at plus 4.6 percent in our forecast, and our risk assessment, as I mentioned earlier, is broadly balanced. Clearly, if the pandemic is resolved faster because of even further vaccination coverage and if the booster is adopted by many, that is going to be an add-on. If more savings are being used by consumers, that will also support consumption, which has been one of the big drivers of the recovery so far. There’s still that, you know, a chunk of saving that was accumulated over the pandemic period, which has not been tapped into, which might be tapped into, so that’s for the upside side of our broadly balanced risk assessment.

On the downside, clearly, we could have a massive fourth wave, or other variants coming to the fore, for which vaccinations don’t work. I mean, you have all these possibilities as well, and the supply bottlenecks, which, as I said, we anticipate, will be circumvented in the first half of ’22, but which could last longer, and which would have a side effect on inflation, putting pressure up, and which would weigh on the Gross Domestic Product (GDP) on the other hand.”

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·         On any possible stagflation like scenario (lower GDP growth, higher inflation, and higher unemployment), Lagarde is quite confident that it will not happen, but also stressed that despite the single mandate of price stability, ECB will ensure maximum employment (like Fed):

“I think you had a second question which had to do with stagflation. You know, our primary mandate is price stability, but we are also keen to see an economy that recovers fully. And for that to happen, of course, jobs have to be created, and the furlough schemes that are in place and that retain employees in their positions but not in actual employment, need to be pursued. And those two million people - still more than in 2019 - that are unemployed, have to also return to employment. So, if that is the ultimate result of this recovery, then I don’t think that we will be heading towards stagflation.”

·         Lagarde clarified three primary conditions for normalization. ECB will end APP and subsequently hike if it sees HICP inflation outlook (expectations) at 2% well ahead of the projection horizon as well as on a durable basis for the rest of the projection horizon. ECB will judge any transitory factors behind elevated inflation and allow it to run moderately higher for some time:

“Well, thank you very much, for this question, it gives me a chance to actually repeat yet again, because I think it’s an important consequence of our last July meeting, the three criteria that are applicable for our forward guidance on interest rates. And that forward guidance, as you know, has been modified and/or clarified to a great extent by including three criteria.

One is, we need to see inflation outlook at target, which is at 2 percent, well ahead of the end of our horizon--First criteria. Second, we need to see it through, also to the end of the projection horizon, and, third, we need to have sufficient elements and an indication of progress in the underlying inflation criteria, at the time when we make the decision.

So, you have these three criteria, and you have the other element of our forward guidance, that remains intact, and which actually plays a role in signaling to markets what will be the sequence of events from asset purchases to interest rate hiking.

·         Lagarde said ECB is still far away from its three goals on inflation and thus thinking about any normalization at this early stage would be premature. Although as an emergency toolkit, ECB will eventually close the PEPP, another QE program APP will be continued even after that till ECB is confident about liftoff (gradual rate hikes). ECB will discuss all these options in Dec’21 meeting:

“I think we are pretty far away from that. And it also gives me a chance to remind all of us that PEPP is a very specific program, intended for the pandemic. It has an emergency character to it, and when that PEPP comes to its term, then clearly, we have all the other instruments available. And in terms of purchases, we clearly have the Asset Purchase Programme, the APP, which we have had on a standing basis ever since October 2019, and that clearly is intended to be continued and will be debated, as I said, at our December meeting. So it’s entirely premature to evoke it, and it has not been discussed on the occasion of this meeting.”

·         ECB Chief Economist Lane recently said the amount of assets ECB will purchase after PEPP finishes will depend on the amount of debt issued by EU member states. Lagarde virtually acknowledged the same. Lagarde said ECB is focused on the overall borrowing program of EU member states (rather than individual) and buying debts (bonds/bunds) in a targeted manner to ensuring favorable financing conditions and robust inflation outlook:


“Now, when we determine our pace of purchases, we are attentive to the entire universe of bonds. We are not paying special attention to the fiscal commitment of one country or the other, or the bond issuance of one country or the other. So, we look at the entire universe of bonds that is available, will be available, and are being announced. And that’s how we determine where our purchase pace is going to be applied. But we do so, as I said, based on two things, under our joint assessment. One is the favourable financing conditions, the second is the inflation outlook.”


·         ECB’s PEPP recalibration decision was unanimous in all respects including the moderate pace of reduction; there was no dissent and divisions among so-called doves and hawks:


“On your question about the decision that we made today, as I said, it was a unanimous decision, in all respects. So, the pace of calibration was agreed, the moderately lower determination was agreed unanimously, it was all unanimous. So, I’m sorry for those who like to set the doves against the hawks, sorry. For this time, there’s not much that you can actually draw from dissenting votes, because we all agreed.”


·         ECB will decide about future of TLTRO in next/Dec’21 meetings which are scheduled to expire in Dec’21; ECB will judge the overall economic and financing conditions; i.e. ECB will be data-dependent:


“TLTROs, you’re right, there will be one more operation in December, and we will clearly have to discuss what comes next on the basis of the situation at the time. I think that that will be part of the overall re-examination that we conduct at the time of our December meeting.


This will be as usual data-dependent, and what we have seen, based on the bank lending survey, based on the discussions that we’ve had with representatives of the banking sector is that TLTROs operations, certainly the earlier ones, more so than the most recent one, have been critically important to help them and encourage them to provide lending to the economy, which they have consistently done over the course of the last two years.”


·         Lagarde ducked the question of buying the inferior quality of debt, like that of Greece after the expiry of PEPP; but assured such ‘longer term’ issues will be taken care of by the ECB at the time of actual decision and it would be premature at this early stage:


“Well, I think it is really too early and unnecessary at this stage to discuss, you know, longer-term issues related to PEPP, and the term of PEPP. As I said, it will be discussed at length, we will enter into a process of a technical review, in-depth analysis of the situation. And certainly, the situation of Greece will be taken into account and addressed specifically, but I think it’s premature for the moment to do so.”


·         Although ECB will discuss the overall economic/financing conditions in Oct/Nov’21 meeting, as usual, the subject of PEPP will be discussed in detail only in Dec’21 as by that time, the ECB can assess its projections for 2021 and achievement (real economic data) along with fresh projections for 2022-24:


“Well, we will all get together around the table, and we will assess the situation, because not a single monetary policy Governing Council meeting goes without us looking at the situation, assessing the financing conditions, and being attentive to the effectiveness of our measures. So, don’t worry, I’m sure we’ll have plenty to discuss and review. But, as I said, the important meeting at which we will discuss the terms and conditions of the PEPP when it comes to its term, will be in December.


You know, at our December meeting, there will be two things. One is, it could well be that our forecast is actually delivered upon, so we have caught up with the two years and we are back to the pre-pandemic, 2019 situation, which doesn’t mean that we are back to , the growth trend that we had in 2019, we are still far away from that, in our forecast. And we will have new projections, which will give us a projection not for 2023, but for 2024. So, we will have more substance to chew on in order to discuss the terms and conditions of the PEPP term.”


·         Lagarde pointed out unlike during the 2008 GFC, this time (COVID), ECB’s monetary stimulus is also accompanied by EZ fiscal stimulus and complementing each other. So far EZ has delivered more COVID/fiscal stimulus than expected, but going forward there is a need for targeted fiscal (infra) stimulus (like NGEU) along with necessary structural reform to rebuild the economy and reduce inequality/fragmentations. In that respect, it would be premature to withdraw monetary stimulus in a hurry because despite clear progress of economic recovery from COVID shock, the economy is still far below 2019 levels and not out of the woods yet:


“---during this crisis, fiscal policy, monetary policy, have been reinforcing each other, unlike in previous situations. The fiscal support that has been extended to all the euro area economies has been critically important, and it has been increased relative to our initial projections. If we look back at, you know, what we forecasted in December last year, and what has so far been the fiscal impulse and the fiscal stimulus given to the economies, there is a significant difference. It has actually, it was more than doubled. So, fiscal policies have been very important, and have supported the monetary policy, as I think we have also complemented, so they really worked hand in hand.


Our assessment is that the fiscal support has to be continued, and as I said on previous occasions recently, it is no longer the massive necessary support across the board to all actors of the economy, as was the case in the beginning of the crisis. It needs to be more targeted, needs to be more surgical, it needs to be associated with the structural reforms that are so much called for and necessary in some countries. And this is really the point about the recovery and resilience plans and the funding that is made available to that effect. That is underway, it will continue to be applied in the quarters and years to come, in consideration for delivery under the plans.


We hope that it will facilitate the recovery and that it will reduce the risk of divergence between countries, and the risk of fragmentation in the recovery process. So, a time will come, of course, when this fiscal support will have to be gradually withdrawn, and where the rules that the Europeans will give to themselves, once they have renegotiated the growth and stability pact, or whatever they call these, the terms under which they operate, that time will come.


But it is still premature and we believe that a lot of the good results that we are seeing for the economy and good reasons for the recovery have to do also with monetary policy, of course, and we should take full credit for that, and fiscal policies. And this has to be continued because we are much advanced in the process, recovery has progressed, is rebounding, but we’re not there yet. We’re not out of the woods. We are not on the green, as the golf players will appreciate. We’re getting closer, but we’re not there yet.”

·         ECB is not concerned about any impact on its monetary policy even if there is a new government in Germany (instead of Merkel’s party)


“The answer to your first question is simple and straightforward: the answer is no. We had plenty to discuss and we did not have any discussion on any change of government in any of the euro area countries, I can assure you.”


·         ECB is not concerned about elevated inflation expectations (5Y forward break-even at 4-years high) as it also looks into several other professional surveys apart from its own, which are not signaling any red flag over the future course of inflation. Although ECB is data-dependent in its policy setting, it’s not data slaves:


“The 5-year-5-year, 1.75 percent number, which as you noted is 50 basis points higher than what it was, which is at the highest in a long time, is something that we pay attention to, but it’s not the only one. We look at all the forecasts, the market survey, the analyst survey, and the forecaster’s numbers. We look at all of that, and we also look at what other institutions are producing, because we don’t want to be data slaves, we are data-dependent in our policy determination, but we want to have a look at a whole range of such data, to make sure that it’s not only directionally in the same vein, but that it’s also consistent., And we look, we do look at the 5-year-5-year, but it’s not the only one, I can assure you.”


·         ECB will use all of its tools at disposal to achieve its mandate/target/objective and if required, will also modify its self-imposed rule of 33% maximum holding of any member state’s debts under APP purchase. But as of now, ECB is not thinking about that and it will be decided in Dec’21 after the decision about PEPP (under PEPP, there is no limitation about debt holding of a particular member state/country):


“Well, on your first question, thank you very much, but those are issues that will be debated in December. So, it’s not a matter for me to debate the exact limits in any shape or form or the capital keys. All I know is that we have a mandate, we have an objective, we have a target that is to be reached, and we will have to use all the instruments that we have available. And we will decide on what terms and conditions will apply at our next meeting, and we will adjust accordingly if necessary.


·         Finally, Lagarde was asked about the disproportionate COVID impact on Southern European states (countries) like Italy and Spain, which are heavily reliant on the tourism/hospitality sector. Lagarde replied that these countries are also benefiting from higher volumes of loans and grants under the NGEU (EU common fiscal stimulus). And if they can deliver as per their submitted plan, then they would in a much better position than earlier. Also, the tourism sector is now reopening rapidly and thus underlying economic recovery may be earlier than previously assumed:


“On your other point, you know, what I observe is that those nations that were most affected by the pandemic, which are large countries from the south of Europe, are the ones that are benefiting from the highest volumes of loans and grants, under the NextGenerationEU. And we very much hope that, with the plans that they have submitted, which have been approved, with the loans and the grants that are already being disbursed and will continue to be so, if there is delivery in consideration, then they will be in a much better position to respond to the damage that was suffered. What we can observe though is that, in relation to tourism, in relation to hospitality services, there has been a significant increase in activity and probably more so than was expected earlier in our projections.”


Bottom line:

Officially, as Eurozone inflation is running consistently well below the +2.0% targets, 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 PEPP tapering from Dec’22 or even Mar’23 after Fed completes its QE tapering by Sep’22 and goes for liftoff from Dec’22 (as expected).

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 (+2% 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!

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 has to fund NGEU at the lowest possible borrowing costs. Even after the August recalibration of PEPP, ECB will still hold around 85% of total Eurozone debt. Like Fed’s Powell, ECB’s Lagarde also emphasizing that although there is good progress of economic recovery, it’s not substantial enough and there is significant slack still in the economy. Thus ECB will ensure a lower rate for a longer policy.

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