Risk warning: Trading CFDs and FX carries significant risk and is not suitable for everyone. You have no ownership of the underlying asset. Pepperstone Financial Services (DIFC) Limited is regulated by the DFSA. Arranging for Pepperstone Group Limited, AFSL 414530, the product issuer.

ECB Preview: Lagarde expected to go again to the PEPP well

1 Jun 2020
The ECB is expected to catch-up with other central banks around the world when it announces an increase in its emergency QE programme (PEPP) by €500bn, which will be accompanied by a longer implementation period until mid-2021. Will this be enough to appease markets who are hopeful that the ECB measures plus the EU Recovery Fund have averted the next existential crisis?

New economic forecasts

In April, the ECB suggested that the outlook for the eurozone economy came in the shape of three possible scenarios and could shrink by between five and twelve per cent this year, depending on the success of the coronavirus containment measures. However, last week President Lagarde commented that the long-awaited new staff macroeconomic projections were likely to lie in between the medium and severe scenarios. For comparison, the European Commission had the economy contracting by 7.7% this year and we know now that the stricter the lockdowns, the bigger hit to the economy. What does seem probable is that the ECB will highlight strongly the uncertainty surrounding the forecasts going forward.

Inflation forecasts will be especially interesting as the latest medium-term projections in March showed the ECB still expected a gradual acceleration in prices. Supply distortions and weaker market competition may have supported this view but increasing unemployment and the widening output gap should see sizeable downward revisions.

Increase in PEPP size needed

The key question for Lagarde will be how much the ECB should increase its bond-buying programme or Pandemic Emergency Purchases Programme (PEPP), as it is likely to be exhausted by October at the current rate of use. As widely expected, the bank front-loaded its purchases to contain volatility and financial fragmentation in certain euro area countries. This has in fact continued longer than forecast so the markets expect Lagarde to address this in order to avoid tightening financial conditions and revisiting the levels from mid-March.

Does the still relatively new President want to encourage unwarranted speculation in the markets if there is no increase to the PEPP and it gets close to being used up? It will be a shock if Lagarde doesn’t play to the narrative of a heightening alertness and readiness to act, especially after her initial faux pas in her first press conference.

No impact from the German Court ruling, backing for the Recovery Fund

Complicating issues is the May ruling from the German constitutional court that effectively limits the participation of the Bundesbank in some ECB QE programmes. The court did not actually rule on PEPP, only on the normal asset purchase programme (APP) which has small monthly volumes of roughly €20bn and of which only German government bonds are affected. Being the statesperson that she is, Lagarde will probably find a way to keep open German demands, but without harming the ECB’s independence or fuelling the conflict. As for the proposed EU Recovery Fund, the ECB will welcome the ambitions of the European Commission while at the same time highlighting the risk of diverging trends within the currency union.

From the most recent comments from ECB members, it seems the bank is now in pre-emptive easing mode with the goal of preventing financial fragmentation. With increased confidence in the global economy, the ECB should step up and deliver more, to further cement the removal of any macro tail risk. Expectant markets and renewed optimism over the ‘next generation EU’ has pushed the euro out of its recent range with spot now targeting the March highs.

Ready to trade?

It's quick and easy to get started. Apply in minutes with our simple application process.

The material provided here has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Whilst it is not subject to any prohibition on dealing ahead of the dissemination of investment research we will not seek to take any advantage before providing it to our clients.

Pepperstone doesn’t represent that the material provided here is accurate, current or complete, and therefore shouldn’t be relied upon as such. The information, whether from a third party or not, isn’t to be considered as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product or instrument; or to participate in any particular trading strategy. It does not take into account readers’ financial situation or investment objectives. We advise any readers of this content to seek their own advice. Without the approval of Pepperstone, reproduction or redistribution of this information isn’t permitted.