ECB research: Steady course, but cautiously optimistic

At next week's ECB policy meeting we expect a repetition of recent comments from various governing council members, thereby striking a cautiously optimistic tone compared to the June projections. We also expect they may decide not to use the EUR1,350bn PEPP envelope in full. No new initiatives are expected next week.

We do not rule out a discussion about adjusting the tiering multiplier taking place, although our baseline remains that any decision to increase the tiering multiplier would occur at a later stage.

Markets may not be prepared for a ‘less dovish' message and with abundant liquidity, PEPP and APP still ongoing, we would use the opportunity to buy into risk on trades in the EGB/Euro fixed income space.

Steady course, but cautiously optimistic

Confidence indicators have pointed to an improvement in the recovery but we are not out of the woods yet (see economic outlook on the next page). As a result, we expect the ECB to strike a cautiously optimistic tone, which suggests that the recession may turn out somewhat milder than it had projected in June but still with quite a serious drop in growth. With the inflation mandate over the medium term, the ECB will not call for a victory yet. That also means we expect the ECB to reiterate the numerous comments from governing council members (such as Schnabel, Villeroy, Knot) that the full EUR1,350bn PEPP envelope may not be needed. Furthermore, Schnabel said that a further expansion of the PEPP may not be needed.

Up until last week, the ECB had been buying at a relatively steady pace of EUR5.7bn/trading day in the PEPP. Last week, PEPP holdings rose only EUR20.2bn, equivalent to EUR4bn/trading day, which is the lowest rate to date under the PEPP. That said, the purchase rate last week corresponds to the required purchase limit to be hit only by end-June 2021. As of now, the ECB is EUR98bn ahead of schedule (average daily purchase rate of EUR5.6bn/trading day) and continuing at this pace would lead to the EUR1,350bn PEPP envelope being exhausted in March 2021. Based on the recent communication, we do not expect the ECB to scale up PEPP again if no further financial fragmentation appears and would expect financial conditions to continue to decline gradually. Therefore, we expect the ECB to slow down its daily PEPP implementation quite markedly. We highlight that should the ECB see the need to scale things up again, it could build a case around a too low/dampened inflationary outlook. Continued flexible PEPP implementation will be reiterated, in our view.

ECB pricing and excess liquidity

Markets continue to price in a rate cut by the ECB and as we do not expect one. We maintain our 1y6m EONIA paying position, as initiated ahead of the June ECB meeting. Markets are pricing 7bp of rate cuts at the trough by the end of next year.As negative interest rates are likely to be with us for a very long time, the ECB has addressed this by introducing the tiering system for reserve remuneration and TLTRO incentives via dual interest rates.

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