MNI SOURCES: ECB Mulls Tweak To PEPP As March Cutoff Nears

The European Central Bank's decision on the future pace of its Pandemic Emergency Purchase Programme at its meeting on Thursday will be taken in accordance with a pre-agreed framework, as the Governing Council engages in what could be three months of intense debate on the scale and mechanism for bond purchases once PEPP's active phase concludes in March, Eurosystem sources told MNI.

With the eurozone economy performing well even as price increases pick up speed and Covid continues to cloud the outlook, officials will apply an agreed set of rules and parameters, including inflation levels, before deciding whether to adjust the pace of purchases, one official said.

"We can't know for sure if we will reduce PEPP purchases in the September meeting," the official said. But other officials said it was likely the ECB would alter guidance for purchases, which currently anticipates them to run "at a significantly higher pace" than during the first months of the year.

"I think buys will be maintained at current levels through the coming quarter," one said. "However, the language may be tweaked to suggest something like 'the pace will be maintained at recent levels, but could be adjusted to accommodate any change in the situation'."

PEPP, currently running at about EUR80 billion per month, could later be trimmed back by around EUR10 billion per month to complete its EUR1.85 trillion envelope for net purchases in March, the official said.

ECONOMIC PROJECTIONS

September's Eurosystem staff growth and inflation projections will be markedly higher than the previous round's, the official added, with average euro area inflation seen hitting 1.5-1.6% by 2023, up from the previous expectation of 1.4%.

Rising inflation in particular will feed debate over the future of asset purchases after March.

Some Governing Council members could call for an additional EUR500 billion to be added to the PEPP envelope, as MNI has previously reported (seeMNI SOURCES: ECB Bracing For September Debate On PEPP Future). Others are arguing for the ECB's older Asset Purchase Programme, which is subject to strict limits including a 33% ceiling on holdings of the stock of any bond issue, to be made more flexible and to be expanded. More conservative national central banks, though, would be reluctant to allow changes to a permanent mechanism such as the APP, which they consider would take it dangerously towards monetary financing.

"There is an overwhelming majority - as the president would say - to say the main reason for the PEPP is over, but the pandemic still has some economic implications," one official said. "It might be a little too early to stop it totally, so let's do either a last prolongation with an additional, smaller envelope and a fixed date. Which only would mean that the discussion about APP would be postponed."

However, the official added, fears that Germany's constitutional court could rule against extending the PEPP beyond a clearly-defined pandemic period could strengthen arguments to make a bulked-up APP more flexible. "I don't think there will be a lot of voices fighting such a decision," the official said.

APP could run at about EUR50 billion during the second quarter, for a total of EUR500 billion for the 12 months until the end of March 2023, another Eurosystem source suggested.

"That's where I see the additional EUR500 billion, rather than an extended PEPP," the source said.

POST-PEPP COMPROMISE

Yet another possibility, according to a former senior ECB source, would be to downsize and rename the PEPP for another quarter or half. "A sort of post-pandemic crisis transition instrument," the official explained. "Not a very clean solution, but this would avoid even more difficult discussions on flexibility in the APP."

Sources largely agreed that it would be difficult to come to any such decision before December. Similarly, it is too early to take determination on new rounds of cheap loans for banks via Targeted Longer-Term Refinancing Operations.

All officials who spoke to MNI agreed that recent inflation increases are likely to be temporary, and will not result in the ECB going close to its new medium-term 2% symmetric inflation target by the end of the projection horizon. But there was also recognition that the situation needs to be carefully monitored.

"The normal thing to happen is that after a stabilisation of the pace of recovery prices will go down again. But what if they don't?" a Eurosystem official said. "I am not saying that this will happen, I am just pointing this out to show that we shouldn't be dogmatic and should keep our eyes open."