MNI STATE OF PLAY: ECB PEPP Seen Nearing End Of Live Phase

The European Central Bank will likely confirm the March end of the net purchase phase of its pandemic-era emergency bond-buying (PEPP) on Thursday, although with inflation running at multi-decade highs, it is less clear whether it will take other key pending decisions, including setting the scale of future bond buys through the legacy asset purchase program.

ECB President Christine Lagarde said in October that, as things stood then, the PEPP program would end on March 31, and, despite the emergence of a new strain of the coronavirus in recent weeks, there is a diminishing appetite among Governing Council members to keep adding to the balance sheet at the current rate.

Lagarde also promised clarity on the ECB's next policy steps in December, with other decisions remaining to be taken including the eligibility of Greek bonds for the asset purchase programmes, and when to end cheap Covid-crisis loans to banks, but the arrival of the Omicron variant and the uncertainty of the inflation outlook mean she may look to keep as many options as possible open for a bit longer.

NO CLIFF EDGE

Policymakers certainly want to avoid a cliff-edge for financial markets as new PEPP purchases end, but there is little appetite for an extended period of purchases under APP, with some members looking for decisions of purchase size made on a quarterly, or even meeting-by-meeting basis. It will be underlined, however, that PEPP remains in the ECB’s toolbox, ready to be reactivated if needed.

The current EUR20 billion per month APP spend may be boosted to as much as EUR 40-60 billion per month, as MNI reported recently, perhaps deployed flexibly over coming quarters. (MNI SOURCES: ECB Seen Buying EUR40-60 Bln A Month After March ).

The pace of PEPP purchases in Q1 will also be decided, with policy hawks feeling these should be progressively ‘recalibrated’ downwards. However, the ECB may ultimately stick to its current guidance and continue at a pace “moderately” lower than that seen this time last year, if only to offer greater flexibility to use the whole of PEPP’s EUR1.85 trillion envelope.

There is little consensus that PEPP's flexibility should become a permanent feature of APP, despite some concern it could see Greece left behind. However, policymakers are unwilling to repeat past errors and an anticipated return to investment grade later this year of Greek sovereign debt means their exclusion from APP would be temporary, with the continued flexibility offered via the PEPP reinvestment programme offering up-front support.

A change to the ECB’s forward guidance that it will raise key interest rates shortly after it ends net purchases under APP has its supporters, but a change is unlikely in December, with Lagarde once again set to rule out any rate hikes until all three conditions laid down by the Governing Council have been met.

PROJECTIONS

This month’s Eurosystem staff macroeconomic projections will see a downward near-term adjustment to the growth forecast, and an upwards revision to the inflation outlook, albeit inflation will likely still be below the ECB’s 2% target in both 2023 and 2024. The debate will continue as to how much higher average HICP inflation can go and how quickly it will fall, but the official narrative will not change this month -- inflation is experiencing a hump that will likely recede in coming months although there are certainly upside risks, as Malta's central bank governor noted to MNI.

Amendments to the ECBs longer term refinancing operations, whether PELTROs or TLTROs, will likely be needed in coming months, but there is no immediate need to decide all in December's meeting, sources told MNI, despite a billing as the moment for total policy recalibration.