ECB Expands and Extends PEPP, after Sharply Downgrading Inflation

ECB’s increase in stimulus was slightly more than we had anticipated. The move was mainly driven by the sharp downgrade in inflation outlook. The decision has sent a strong message to the market that the central bank is “undeterred” by German constitutional court’s ruling and will continue to adjust the monetary policy as appropriate.

At the June meeting, ECB raised the size of the pandemic emergency purchase program (PEPP) by 600B euro to a total of 1,350B euro. The increase was 100B euro higher than what we had anticipated. Meanwhile, the program is extended to the end of June 2021, and could continue beyond this until the central bank “judges that the coronavirus crisis phase is over”. The central bank also announced the plan to reinvest the proceeds from the PEPP purchases until at least 2022. Other policies, including policy rates, APP and forward guidance, stays unchanged.

On the macroeconomic projections, ECB forecasts Eurozone’s economy to contract by
-8.7% this year and then return to growth of +5.2% and +3.3% in 2021 and 2022, respectively. Inflation is projected to only reach +0.3% y/y this year, followed by modest improvement to +0.8% and +1.3% in 2021 and 2022, respectively. The forecasts suggest that the bloc’s inflation will stay far below ECB’s +2% throughout the forecast horizon.

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Today’s decision indicates that ECB is determined to revive the economy using more ammunition. Depending on the economic developments, it is likely that ECB will have to expand the size PEPP again. Indeed, the increased envelope of the PEPP would be
exhausted in late February 2021, if ECB maintains the current pace of asset purchases.