Eurozone monetary policy to remain relatively accommodative, for now

Summary

The European Central Bank's (ECB) December 16 monetary policy announcement looms as a key event for market participants, as the central bank considers whether to bring its emergency asset purchase program to an end.

Economic trends are mixed heading into the announcement, with growth slowing and inflation quickening. Still, we expect the recent spike in inflation will be enough for the ECB to end its Pandemic Emergency Purchase Program (PEPP) in March 2022, as scheduled. While we expect the ECB will maintain flexibility over the total size of its PPP purchases, we believe purchases will ultimately come in slightly below the €1.85trillion purchase envelope.

We also expect the ECB to provide short-term guidance for its asset purchases once the PEPP program ends. Specifically, we expect the ECB to announce that forQ2-2022, purchases under the Asset Purchase Program (APP) will increase from€20B per month to €50B per month.

Over time, we believe the longer-term implications of the ECB's announcement will be a softening EUR/USD exchange rate trend. The Fed likely will both taper its bond purchases and raise interest rates more quickly than the European Central Bank, which in turn is likely to make only a gradual shift towards less accommodative monetary policy.

European Central Bank approaching key milestone along monetary policy path

The European Central Bank's (ECB) December 16 monetary policy meeting will likely be the most consequential in some time, as policymakers grapple with conflicting trends in growth (slowing) and inflation (quickening), and consider whether to bring bond purchases under the Pandemic EmergencyPurchase Program (PEPP) to an end. In recent comments, ECB President Lagarde suggested that some adjustments could be announced at this month's meeting. Speaking to Reuters, Lagarde said the ECB may set policy for a relatively short period at this month's meeting given heightened uncertainty, but should not delay a decision as markets need direction.

As policymakers and market participants head into the December meeting, there are overall signs of slowing Eurozone growth. The manufacturing and service sector PMIs have been steadier in recent months, printing at 58.4 and 55.9 for November respectively. However, they are still well below the highs seen earlier this year, with the manufacturing PMI peaking at 63.4 in June and the services PMIpeaking at 59.8 in July. In addition, COVID cases have recently rebounded across the region and some countries have reimposed partial restrictions–notably Germany and Austria–prompting some near-term uncertainty to the outlook. At the same time, CPI inflation spiked higher to 4.9% year-over-year in November, although the acceleration in the core CPI so far has been somewhat less marked, to 2.6%year-over-year.

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