Global Weekly Commentary: ECB - keeping up the pace
The ECB in focus
We expect the European Central Bank (ECB) to maintain its current pace of asset purchases even though the economic restart is gaining moment.
U.S. nonfarm payrolls growth picked up in May. We caution against extrapolating too much from erratic near-term data amid a powerful restart.
U.S. inflation data will also be in focus this week. A high core consumer price index (CPI) reading could fuel talks of tapering by the Federal Reserve.
We expect the ECB to maintain its current pace of asset purchases even as the economic restart gains traction. We wouldn’t view a decision to slow purchases as a hawkish policy signal, as the ECB is focused on keeping financing conditions easy. This, and a Federal Reserve that we see keeping policy easy, provides a positive backdrop for risk assets including European equities, in our view.
Chart of the week
Actual and projected euro area and U.S. inflation, 2006-2023
Sources: BlackRock Investment Institute, the Federal Reserve Board and Bureau of Economic Analysis, with data from Refinitiv, June 2021. Notes: The orange dots represent consensus expectations for ECB staff inflation projections due this month. Fed projections refer to the Fed’s Summary of Economic Projections from March 2021. Euro area headline inflation refers to the Harmonized Index of Consumer Prices (HICP). U.S. core PCE inflation refers to the personal consumption expenditures price index, excluding food and energy.
Financing conditions in the euro area tightened late last year and in the first quarter of 2021, but have since stabilized and still appear supportive of growth. Yet the region’s inflation outlook – the primary consideration in the ECB’s policy decisions – remains weak. Consensus expectations see ECB staff projections due this week showing 2023 inflation still materially undershooting the bank’s target of below but close to 2%. In contrast, the U.S. core personal consumption expenditures (PCE) inflation – the Fed’s preferred inflation measure – has shot up above the 2% target. It will likely hover at or just above target over the next two years, according to the Fed’s latest Summary of Economic Projections. See the chart above. This underpins our expectation for the ECB’s policy support to stay put – regardless of its decision on the pace of asset purchases this week. In addition, we caution against reading too much into strong near-term growth data. We are experiencing an economic restart rather than a typical business cycle recovery; the usual business cycle playbook doesn’t apply, in our view.
We expect the ECB to maintain its current pace of asset purchases under the pandemic emergency purchase program (PEPP) this week, despite a likely upgrade to its growth projections. The central bank is squarely focused on maintaining easy financing conditions. An unwarranted tightening in financing conditions, partly as a result of rising U.S. bond yields earlier in the year, prompted the ECB to quicken the pace of its asset purchases in March. Since then, the euro area has been catching up on activity restart, amid still supportive financing conditions.
Even if the ECB were to reduce its pace of asset purchases, we would view this as an operational decision rather than a policy decision. The ECB has committed to maintain its policy support for the duration of the pandemic crisis – at least until early 2022. Beyond that, we expect policy support to remain in place given an outlook that points to inflation staying far below target, with further asset purchases likely conducted through the extension of other asset purchase programs.
We see both the Fed and ECB likely upholding their accommodative policy stances. Inflation – not the near-term growth outlook – is key to the Fed’s rate outlook under its new policy framework, in our view. The strong activity restart in the U.S. has led to unusual supply and demand dynamics, and volatile near-term growth and inflation data. Long-term U.S. government bond yields have risen this year, but the rise has been more muted than typically seen in response to rising inflation and growth expectations in the past – in line with our new nominal investment theme that sees a lower future path of short-term interest rates than markets are pricing in even amid rising inflation. We don’t see the Fed discussing a tapering of asset purchases imminently – and a discussion later this year doesn’t mean a liftoff from near-zero policy rates is close, in our view. The case for tapering – or monetary policy normalization – in the euro area is even weaker, in our view.
The bottom line: We see the ECB’s commitment to accommodative policy as supporting our pro-risk stance over the tactical horizon as the reopening broadens out. We upgraded our tactical view on European equities to neutral in February, and are seeing more reasons to be optimistic about this asset class for the next six to 12 months. Yet we see a risk that markets could misinterpret an operational decision to slow the pace of purchases as a more hawkish view on policy stimulus, and we would view any spread widening in euro area peripheral bonds in such an event as a buying opportunity.
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