The European Central Bank left monetary policy unchanged today, in line with market expectations, as virus developments and the extension and tightening of lockdown measures didn’t prove dramatic enough to prompt any change of course.
At first glance, the press statement does not seem to contain much additional information from what was released back in December. The immediate market reaction to the statement was therefore limited, with only a 2bp climb in German bund yields and the euro trading flat against GBP while trading only 0.15% higher vs USD. However, the euro has continued to rally as the event progressed.
The main takeaway from today’s statement may be the ECB’s potential reluctance to spend the full PEPP amount, as the following paragraph was included in the statement:
The purchases under the PEPP will be conducted to preserve favourable financing conditions over the pandemic period. If favourable financing conditions can be maintained with asset purchase flows that do not exhaust the envelope over the net purchase horizon of the PEPP, the envelope need not be used in full. Equally, the envelope can be recalibrated if required to maintain favourable financing conditions to help counter the negative pandemic shock to the path of inflation.
The fact that this has been mentioned in the press statement is the first clear indication that the ECB may not deploy the Pandemic Emergency Purchase Programme in full. On balance, this is a slightly more hawkish tilt than the previous statement and gave insight into the positive tone President Lagarde would strike in the following press conference.
During the press conference, ECB President Christine Lagarde maintained a moderately optimistic tone, similar to the December press conference, despite the deterioration in economic conditions over Q4 2020 and January 2021.
Lagarde looked towards positive Brexit developments, progress in vaccines, along with EU and US fiscal stimulus to offset the near-term economic headwinds posed by lockdown measures. Lagarde elaborated on the above paragraph in the statement and discussed that the ECB assesses financing conditions and aims to keep them favourable during the pandemic by considering bank lending rates as well as corporate and sovereign bond yields, calling this the holistic and multi-faceted approach. Comparisons in the ECB’s approach can be drawn with yield curve control policies– a strategy that is implemented by the Bank of Japan and can be implemented by most major G10 central banks, but one the ECB can’t draw upon as it needs to manage the monetary needs of 19 nations with 19 debt levels and instruments. The ECB may be purchasing bonds to limit the differences between riskier and less risky sovereign bond yields as such, which could explain why the BTP-Bund spread has remained relatively stable despite Italian political risks creeping back up. Despite journalists pressing Lagarde on this issue, she reiterated multiple times that the ECB’s policy measures look at a broad suite of financing conditions, not just sovereign yield curves.
By aggressively targeting yields to narrow the spread, the ECB can lower bond yields across the single markets and lead to a more even recovery in the eurozone, thus improving the growth outlook.
The distribution of purchases will therefore be a key variable to watch for the euro and the eurozone as a whole, especially as the BLS bank lending survey signaled that financial conditions are starting to deteriorate in some areas. For now, today’s meeting left no big impression with the euro, with EURUSD continuing to trade within this week’s range.
EURUSD only moderately rallies throughout ECB press conference
Author: Ima Sammani, FX Market Analyst