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Intesa Sanpaolo : ECB concentred on the PEPP and TLTRO-III programmes

Intesa Sanpaolo : The European Central Bank has announced what is expected to be the last slackening of monetary policy in the present cycle and, as expected, concentred on the PEPP and TLTRO-III programmes.

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Weekly Economic Monitor – 11. December 2020 

Intesa Sanpaolo – Research Department


The balance of risks to the forecast scenario remains skewed to the downside, but less markedly so. The staff has confirmed its forecast of a recovery in 2021 and 2022, although average growth in 2021 has been revised down due to the contraction that is now expected at the end of fine 2020.

– The measures announced by the European Central Bank as part of its December “recalibration” of monetary policy were essentially in line with expectations. The developments which followed the meeting at the end of October, and in particular the prospect of a mass anti-COVID 19 vaccination campaign in the course of 2021, and signals that the impact of the second wave of the pandemic would be significantly smaller than the first wave’s, had eased pressures on the central bank. Furthermore, market expectations had been guided by rather punctual interviews and speeches ahead of the meeting.

– In detail, the European Central Bank has announced the following stimulus measures:

* PEPP: the ceiling has been raised from 1350 to 1850 billion euros: the termination of the net purchases has been pushed back to March 2022. Reinvestment of the principal payments from securities upon maturity will continue to be full until the end of 2023. We expected net purchases to end in December, but the overall plafond is in line with our forecasts. The flexibility of the PEPP (geared to preventing an unwelcome tightening of financial conditions during the crisis) implies in any case that the flow of purchases could be drastically reduced in the event of the recovery in 2021 proving more vigorous than expected, or stepped up in the opposite case. If starting in December purchases were in line with the average for the past five months, the extension until March 2022 would allow to use the plafond in full.

* TLTRO-III: the programme underwent the technically most complex intervention. As expected, the period in which negative rates will be applied has been extended: instead of ending in June 2021, it will now end in June 2022 (6 months later than we had anticipated). Furthermore, three auctions have been added (June, September, and December 2021) to those already scheduled (we expected two more). As forecast, the extension of the TLTRO-III programme has required an expansion of the pool of eligible loans to refinance, albeit smaller than estimated (from 50% to 55% of the stock as at 28 February 2019). On the other hand, the ECB has set a new target for the volume of loans extended “In order to provide an incentive for banks to sustain the current level of bank lending”. The new target for lending to non-financial corporations and families (excluding mortgages) is 0% between 1st October 2020 and 31st December 2021.

* Collateral: another reasonable measure, anticipated by executive board member Lane a few days ago, is the extension until June 2022 of the “collateral easing measures adopted by the Governing Council on 7 and 22 April 2020”, that will be re-examined before that date.

* Secondary measures: the announcement also includes four PELTRO long-term refinancing operations in 2021, all with a duration of one year, and a cost equal to refi rate minus 25bps.

– No changes to forward guidance and policy rates, nor to the APP. The deposit rate, the rate on the main refinancing operations, and the marginal refinancing rate were left respectively at -0.50%, 0%, and 0.25%. As before, the ECB warns that these rates will remain at levels not higher than the present “until we have seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2 per cent within our projection horizon, and such convergence has been consistently reflected in underlying inflation dynamics”; net APP purchases will “run for as long as necessary to reinforce the accommodative impact of our policy rates”, and will “end shortly before we start raising the key ECB interest rates”; reinvestment of the principal payments from maturing securities purchased under the APP will continue in full “for an extended period of time past the date when we start raising the key ECB interest rates”.

– As regards the staff’s macroeconomic forecasts, estimated GDP changes were revised up for 2020 (-7.3%), down for 2021 (+3.9%), and up for 2022 (4.2%). The ECB expects GDP to contract by -2.2% in 4Q 2020. Risks are still considered to be skewed to the downside, but “less pronounced” than in September. Inflation forecasts were revised up for 2020 (0.2%) and 2023 (1.4%), but left unchanged for 2021 (1.0%). Underlying pressures will remain “subdued” due to industry-related factors (tourism, travel), but also as a result of the appreciation of the exchange rate, and of low wage pressures.

– Once again, the ECB staff has also drawn up alternative scenarios. The ECB’s “severe” scenario assumes that some containment measures will be left in place until the end of 2023, and that the persistent effects of the crisis will be stronger. Furthermore, this scenario also assumes a sharper contraction in 4Q 2020 (-3.2% q/q). In 2021, GDP will remain almost unchanged (+0.4% y/y), and the recovery falls short of the baseline scenario in 2022 as well (+3.0%). Under the best-case scenario, growth in 2021 will reach 6.0%, staying higher than 4% in 2022 as well.

If the baseline scenario proves to be correct, this should be the last round of monetary stimulus announced by the ECB in the present cycle. A long observation period begins today, that will extend at least until the end of next spring. Until then, a worst-than-expected third wave of contagion may create some expectation of further monetary easing, but unless the vaccination campaign is derailed, new stimulus is unlikely to be approved by the governing council. The FT reports that resistance to stimulus measures is rising, and that it has already led to a downsizing of the proposed changes to the TLTRO-III programme at the December 10th meeting. Subsequently, most probably from September onwards, a debate on the opportunity to scale-back the stimulus may begin within the Council, should the pace of the recovery prove to be faster than expected. However, the potential reaction to this scenario should initially be limited to a slowdown in the implementation of the PEPP, with no resulting official corrections of the monetary policy setting.

FOMC: focus on asset purchases. At the December meeting, the Committee will concentrate on the purchase programme, announcing new forward guidance on the balance sheet, that should be “well coordinated” with guidance on rates. In view of the likely approval of a new fiscal package at the end of the year, the FOMC should not consider it necessary to step up monetary stimulus in December, while remaining ready to act as appropriate, especially in case of failure of the current negotiations over new fiscal aid.

– The December FOMC meeting should follow up on the indications provided by the November minutes, announcing forward guidance on the asset purchase programme, “well coordinated” with guidance on rates.

– The Committee could also explicitly lay out the sequence of actions on the expansionary instruments in use, indicating that once the conditions laid out in forward guidance are met, purchases would be reduced first, followed only at a later stage by rate hikes. The reduction of purchases should be conditioned to the evolution of the employment and inflation pictures, as for rates. Currently, the FOMC expects that rates will remain steady “until labour market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time”.

– The FOMC seems likely to signal that getting close to the required conditions to act on rates could trigger balance sheet adjustments. In our view, based on the macro picture, in 4Q 2021 the time could be right for the beginning of the end of the QE programme, opened to counted the COVID pandemic, on condition of the evolution of the economic and health pictures next year proceeding as expected.

– On the other hand, for what concerns the possibility of stepping up existing stimulus by making changes to the purchase programme, we believe the Committee will stay on hold and abstain from changing the size of purchases (80 billion in Treasuries, and 40 billion in MBS and CMBS). While it is true that near-term risks are skewed to the downside due to the deterioration of the health picture, the recent progress made on the anti-COVID front point to an easing of such risks in terms of 1Q growth. In fact, when the FOMC will meet, there should be greater visibility on the probability (which remains high) of the stimulus package being approved, worth around 900 billion dollars and currently being discussed in Congress. The comments made by FOMC participants were mostly consistent with a confirmation of the status quo, and stressed the importance of fiscal policy in supporting final demand.

– The assessment of the current macro conditions and of the economic outlook in the December statement should highlight the ongoing, moderate expansion of economic activity, supported by consumption and by investment, both residential and non-residential, while also stressing the slowdown of the job and consumption trends, together with the mounting risks tied to the deterioration of the health picture and to restrictions imposed by the authorities in many States. During the press conference, Powell should provide a more detailed commentary of the twofold outlook, for the near and medium terms, highlighting downside risks between the end of 2020 and the beginning of 2021, and upside risks in the second half of 2021 and in 2022.

– The updated macroeconomic forecasts for December should point to higher GDP and inflation, a lower unemployment rate in 2020, confirm the positive outlooks for 2021 and 2022, while keeping intact the stable path for rates all along the forecast horizon (2023). As a result, the FOMC should further confirm its accommodative stance.

– Both the statement and the press conference should stress the combination of downside risks in the near term and upside risks in the medium term, tied to the current acceleration of Covid infections, and the expected widespread administration of vaccines in the first half of 2021. Powell should underline expectations for the approval of the new fiscal stimulus package being discussed in Congress, while reasserting the Fed’s readiness to act as needed with new measures, especially if Congress doesn’t end the year with new fiscal stimulus.


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