ECB preview: First step to a soft exiting while keeping flexibility

The ECB meeting on Thursday next week will focus on the financing conditions, PEPP implementation, and cautiously optimistic view on-demand amid a weak CPI outlook. ECB is expected to raise its growth projections by 0.3pp for this year and next year.

We expect ECB’s PEPP purchase guidance to shift from ‘significantly’ to ‘moderately’ higher than at the start of the year, i.e. we expect PEPP buying to be EUR70bn/ month in Q3 versus the current net purchase pace of EUR80bn/month.

We do not expect the meeting will alter our tactical nor strategic view on the rates (range trading & spread compression) outlook or FX (strategically stronger USD).

A balancing act – normalizing, and keeping flexibility

It will be a challenging communication exercise that awaits Lagarde on Thursday next week. We expect that she and the ECB GC will convey a narrative of higher growth, with a still subdued inflation outlook yet at the same time also slow the current PEPP purchases slightly. At the current juncture, we believe it is fair to argue both for a lower but also unchanged PEPP net purchase pace given that we are still in the early phase of re-opening the European economies. Stournaras, Panetta, and Villeroy indicated a preference to not taper PEPP purchases while Schnabel and Kazaks have fallen short of endorsing a similar conclusion.

Our preferred measures of ECB financing conditions - what to watch - updated, 21 May, are not concerning to a significant degree which also seems to be shared among various GC members. However, while financial markets have been broadly stable since the March ECB meeting, concerns about the tighter credit conditions (as also reflected in the April bank lending survey) and the risks thereof must be of concern.

We, therefore, expect a compromise on PEPP between going back to the Jan/Feb purchase pace (around EUR60bn/month) and keeping the current pace (around EUR80bn/month) to land around EUR70bn/month in Q3, but 15-20% lower in August due to seasonality, with the strengthening of the flexibility of the PEPP.

Transferring PEPP to APP? Not yet

While market speculation has picked up on transferring PEPP modalities to the APP from March 2022 where the net PEPP purchases is currently expected to end, we do not expect such discussion to take place until the fall of this year. Furthermore, as the PEPP is designed to address the COVID-impaired inflation and growth shortfall and PEPP's direct link to financing conditions, we do not take it as given that this will happen.

We believe that such discussions will be done on a bigger review and overall calibration of the instruments later this year, where we also expect TLTRO and tiering will be discussed.

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