MNI POLICY: PEPP Boost A 'Proportionate' Response - ECB's Lane

By Luke Heighton

     FRANKFURT (MNI) - The European Central Bank's EUR600 billion increase to

the Pandemic Emergency Purchase Program was a "proportionate" response to the

rapid deterioration of the economic and inflation outlooks for the euro zone,

and the "significant" tightening of financial conditions caused by the

"extraordinary recession' triggered by the Covid-19 crisis, chief economist

Philip Lane wrote in a blog post published Friday.

     "Once the negative pandemic shock has been successfully managed," Lane

continued, "the primary focus of monetary policy can return to its underlying

strategic goal of robustly achieving our inflation aim over the medium term."

     Germany's Constitutional Court ruled in May that unless the Bundesbank

could demonstrate within three months the "proportionality" of the ECB's Public

Sector Purchase Program operations, it would no longer be allowed to participate

in them - casting doubt over the future of PEPP.

     Here are the key points from the article:

     --The baseline Eurosystem staff macroeconomic projection scenario

anticipates a decline in output of 13% in Q2 2020, with quarterly growth rates

of 8.3% in Q3 and 3.2% in Q4. Annual growth is projected to average -8.7% in

2020, 5.2% in 2021 and 3.3% in 2022. Headline inflation of 0.3% is expected in

2020, 0.8% in 2021 and 1.3% in 2022. Core inflation is forecast to reach only

0.9% in 2022.

     --Two factors called for further expansion of the PEPP: "First, without a

sufficient policy response, the pandemic-related negative shock to the inflation

path poses a threat to medium-term price stability [...] Second, while

conditions in financial markets have stabilised substantially since the PEPP

announcement, the situation remains fragile. This fragility underlines the

continued need for the central bank to be flexible and exercise a market

stabilisation function to the extent necessary."

     --Increasing the PEPP envelope "protects smooth policy transmission and

supports lower funding conditions for the real economy, with the aim of lifting

the medium-term inflation projection closer to the pre-crisis expected

trajectory."

     --Extending the temporal horizon of the PEPP to "at least" the end of June

2021 "broadly aligns the purchase horizon with the horizons of our other

monetary policy measures taken in response to the pandemic, such as the TLTRO

III and PELTRO programmes," Lane continued.

     - The decision to reinvest maturing principal payments from securities

purchased under the PEPP until at least the end of 2022 corresponds with the end

of the ECB's current projection horizon. "This reinvestment strategy," Lane

writes, "avoids the risk of an unwarranted tightening of financial conditions at

a time when the recovery from the pandemic shock remains incomplete, while also

ensuring that the management of the wind-down phase will not pose obstacles for

the ongoing conduct of monetary policy." 

     - At the same time, he adds, "it is appropriate that the reinvestment

strategy for the PEPP reflects its temporary nature and link to the pandemic

emergency."

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

[TOPICS: M$X$$$,MT$$$$,M$$EC$]