ECB preparing the ground for more bond purchases - Capital Economics
European Economics

ECB preparing the ground for more bond purchases

European Economics Weekly
Written by Jack Allen-Reynolds
The account of April’s ECB meeting, and some recent comments from senior members of the Governing Council, suggest that the ECB is gearing up to increase its bond purchases. Next week, the European Commission will publish its proposal for a collective EU fiscal response to the crisis, but there is still a wide range of views among member states over what form any fiscal support should take.

Policymakers have more work to do

The account of April’s ECB meeting, published today, shows that the Governing Council has left the door wide open to further monetary policy support.

As a reminder, at that meeting the Council made the Targeted Longer-term Refinancing Operations (TLTROs) more generous and announced a new series of ultra-cheap loans: the Pandemic Emergency Longer-term Refinancing Operations (PELTROs). The first PELTRO operation was conducted this week, but it attracted very little interest.

Policymakers have hinted that increased bond purchases are coming. The account said that with new ECB forecasts available in June, “at that point, the Governing Council would have to stand ready to adjust the PEPP and potentially other instruments”. Similarly, in a speech this week the Bank’s Chief Economist Philip Lane concluded by saying that the Council was “fully prepared to further adjust [its] instruments if warranted. This includes increasing the size of the PEPP and adjusting its composition, by as much as necessary and for as long as needed”.

Admittedly, the account showed that the usual suspects still have reservations about asset purchases. But they are likely to be in a minority, so we doubt that this will stop the ECB from doing more. At the current rate, the €750bn available under the PEPP will run out in October, and policymakers will be keen to avoid a re-widening of bond spreads as that date draws nearer. The account said that “pre-emptive action” is the best way to avoid losses of investor confidence, suggesting that Council will want to increase the PEPP sooner rather than later.

Meanwhile, the account also noted that “an ambitious and coordinated fiscal stance was critical”, so most members of the Council will presumably have been cheered by this week’s joint proposal from Germany and France.

In our view, it still looks small relative to the costs of the crisis (see here), and Italy’s Prime Minister has said that the EU needs to do “much more”. By contrast, the self-styled “Frugal Four” countries have objected to the plan and intend to publish a counterproposal. The European Commission will present its own plan next Wednesday.

Data highlight differing effects of lockdowns

Data published this week for March showed huge falls in construction in France and Italy, but small increases in Germany and the Netherlands. (See Chart 1.) Those differences reflect the variation in the virus containment measures between countries, and will also be evident in the official data for April when they are released next month.

Chart 1: Construction Output (% m/m, March)

Source: Refintiv

The flash PMIs for May were published this week too, and suggest that the disparity between Germany and France narrowed as lockdowns were eased. (See here.) The daily data that we track point to a modest pick-up in other countries too (see here), though activity is still well below normal levels. (See here.)

Looking ahead, economies that are more dependent on the hospitality sector and international tourism are likely to recover more slowly. That group includes France, Italy, Spain and Greece, whereas Germany and the Netherlands should fare better.

The week ahead

Our London “office” will be closed on Monday 25th for a UK Bank Holiday. But we expect data released later in the week to show a small increase in economic activity in May, while in the same month headline inflation was unchanged at 0.3%.


Data Previews

Germany GDP (Q1, Fin.) Mon. 25th May

Forecasts

Time (BST)

Previous

Consensus

Capital Economics

German GDP q/q(y/y)

07.00

-2.2%(-2.3%)p

-2.2%(-2.3%)

-2.2%(-2.3%)

No component unscathed apart from government consumption

We expect the final estimate of German Q1 GDP to confirm that the economy contracted sharply last quarter and that consumption, investment, exports, and imports all took a beating.

Since the first Q1 GDP estimate was published on 15th May we have not had any new data to suggest that it will be revised. The focus will therefore be on the expenditure breakdown.

We already know from the press release of the initial estimate that household consumption “fell sharply”. Monthly retail sales data suggest that, after stagnating in Q4, household consumption fell by around 0.5% q/q. But we suspect that other sales (which account for around half of consumption) will have slumped, so have pencilled in a 1% q/q drop. Meanwhile, investment is likely to have sunk by about 8.5% q/q – a worse quarterly performance than during the depths of the global financial crisis. Destatis noted that while construction investment held up well, machinery investment “decreased considerably”.

Finally, the flash GDP press release also noted that both exports and imports saw “strong declines” and we suspect net trade was a drag on growth. (See Chart 2.) Monthly trade values data point to a 3.5% q/q drop in exports and a smaller fall in imports.

Looking ahead, the lockdown affected more of Q2 than Q1, so Q2 is set to be considerably worse. Past that the economy will recover, albeit slowly.

Chart 2: Contributions to Quarterly German GDP Growth (%-pts)

Source: Refinitiv, Capital Economics

German Ifo Survey (May) Mon. 25th May

Forecasts

Time (BST)

Previous

Median

Capital Economics

Business Climate Index for Germany

09.00

74.3

78.6

80.0

Bouncing back

We suspect that the Ifo Business Climate Index (BCI) bounced back a bit in May as the economy starts to benefit from the easing of the lockdown.

The BCI collapsed to a record low of 74.3 in April, as measures to contain the spread of the coronavirus across Europe took their toll on the German economy. As Germany started to ease restrictions on 20th April, this month’s BCI is likely to have risen. The “current business situation” component may have fallen further – similar to the current situations index of the ZEW. But business expectations for the next six months might not be quite so grim now that the German government has started easing restrictions. The rise in Germany’s Composite PMI this month also suggests that the Ifo will have risen.

We have pencilled in a rise in the BCI to 80.0. That would be broadly consistent with the economy contracting by around 5% y/y in the middle of Q2. (See Chart 3.) We are forecasting an even bigger year-on-year contraction in Q2 GDP of 11%.

Chart 3: German Ifo BCI & GDP

Sources: Refinitiv, Capital Economics

Euro-zone EC Economic Sentiment (May) Thu. 28th May

Forecasts

Time (BST)

Previous

Median

Capital Economics

Economic Sentiment Indicator

10.00

67.0

70.0

80.0

Climbing back up

The easing of restrictions means that the European Commission’s Economic Sentiment Indicator (ESI) probably rose in May, but not by enough to reverse the previous month’s decline.

The ESI recorded its largest ever monthly drop in April, falling to just 67.0, as lockdown measures brought activity to a halt. We already know that consumer confidence, which accounts for 20% of the index, improved in May. And business confidence is likely to have improved too as firms have been allowed to reopen their doors over the past month or so. The rise in the euro-zone Composite PMI this month points to around a 10-point increase in the ESI.

We have pencilled in an increase in the euro-zone ESI to 80, which would leave it still pointing to a sharp annual contraction in GDP in the middle of Q2. (See Chart 4.)

Chart 4: ESI & GDP

Sources: Refinitiv, Capital Economics

Euro-zone Flash CPI (May) Fri. 29th May

Forecasts

Time (BST)

Previous

Median

Capital Economics

HICP m/m (y/y)

10.00

+0.1% (+0.3%)

-0.1%(+0.1%)

+0.1%(+0.3%)

Core HICP m/m (y/y)

10.00

+0.8% (+0.9%)

+0.6% (+0.7%)

Headline rate to remain

We think that inflation will have held steady at a low level in May, but it is likely to fall further in the coming months.

Headline HICP inflation fell to 0.3% in April, as declines in the core and energy components were partly offset by a jump in food inflation. Difficulties in collecting prices due to the lockdowns meant that statisticians had to rely more than usual on estimations last month. But as price data are usually collected around the middle of the month, the easing of lockdowns in the first half of May should have made data gathering a little easier.

In May, we suspect that food inflation probably picked up further, as labour shortages caused difficulties in harvesting agricultural produce. And with oil prices having recovered a bit this month, the drag from energy inflation on the headline rate won’t be quite as substantial as it was in April. But these effects are likely to have been offset by a fall in the core rate, to 0.7%. After all, May’s PMI survey showed that output prices fell sharply for the third month in a row, as firms continued to offer discounts to help boost sales. Overall, we think the headline rate will have been unchanged at 0.3%.

Looking ahead, the drag from energy inflation is likely to continue to ease (see Chart 5) and supply issues will keep food inflation higher over the summer. But with underlying inflation set to edge lower, the headline rate has further to fall.

Chart 5: Oil Price in Euros & Energy Contrib. To HICP

Sources: Refinitiv, Capital Economics


Economic Diary & Forecasts

Upcoming Events and Data Releases

Date

Country

Release/Indicator/Event

Time CET

Time (BST)

Previous*

Median*

CE Forecasts*

Mon 25th

CE

Capital Economics London Office Closed, UK Bank Holiday

Ger

GDP (Q1, Final, q/q(y/y))

08.00

(07.00)

-2.2%(-2.3%)p

-2.2%(-2.3%)

-2.2%(-2.3%)

Ger

Ifo Survey (May)

10.00

(09.00)

74.3

78.6

80.0

Tue 26th

Ger

GfK Consumer Confidence (Jun)

08.00

(07.00)

-23.4

-19.0

Wed 27th

Fra

INSEE Business Confidence (May)

08.45

(07.45)

62

69

Fra

Consumer Confidence (May)

08.45

(07.45)

95

94

Thu 28th

Spa

CPI (May, EU Harm., Flash)

09.00

(08.00)

+0.4%(-0.7%)

0.0%(-0.9%)

Spa

Retail Sales (Apr)

09.00

(08.00)

-14.3%(-14.1%)

EZ

EC Business & Consumer Survey (May)

11.00

(10.00)

67.0

70.0

80.0

Ger

CPI (May, EU Harm., Flash)

14.00

(13.00)

+0.4%(+0.8%)

-0.2%(+0.4%)

Fri 29th

Fin

GDP (Q1, q/q(y/y))

07.00

(06.00)

-0.7%(+0.4%)

-2.5%(-2.1%)

Ger

Retail Sales (Apr)

08.00

(07.00)

-5.6%(-2.8%)

-9.0%(-12.0%)

Fra

GDP (Q1, Final, q/q(y/y))

08.45

(07.45)

-5.8%(-5.4%)p

-5.8%(-5.4%)

-5.8%(-5.4%)

Fra

CPI (May, EU Harm., Flash)

08.45

(07.45)

0.0%(+0.4%)

0.0%(+0.3%)

Fra

Consumer Spending on Goods (Apr)

08.45

(07.45)

-17.9%

Ita

GDP (Q1, Final, q/q(y/y))

10.00

(09.00)

-4.7%(-4.8%)p

-4.7%(-4.8%)

-4.7%(-4.8%)

EZ

M3 Money Supply (Apr)

10.00

(09.00)

(+7.5%)

EZ

Flash CPI (May)

11.00

(10.00)

+0.3%(+0.4%)

-0.1%(+0.1%)

(+0.3%)

Ita

CPI (May, EU Harm., Flash)

11.00

(10.00)

+0.5%(+0.1%)

-0.1%(-0.1%)

Selected future data releases and events

Tue 2nd

EZ

Markit Manufacturing PMI (May, Final)

10.00

(09.00)

39.5p

39.5

Wed 3rd

Ger

Unemployment Rate (May)

09.55

(08.55)

5.8%

EZ

Unemployment Rate (Apr)

11.00

(10.00)

7.4%

Thu 4th

EZ

Markit Composite PMI (May, Final)

10.00

(09.00)

30.5p

30.5

EZ

Retail Sales (Apr)

11.00

(10.00)

-11.2%(-9.2%)

Gre

GDP (Q1, q/q(y/y))

11.00

(10.00)

-0.7%(+0.5%)

-5.0%(-4.2%)

EZ

ECB Interest Rate Announcement

13.45

(12.45)

-0.50%

-0.50%

*m/m(y/y) unless otherwise stated. p=provisional.

Sources: Bloomberg, Capital Economics

Main Economic & Market Forecasts

%q/q(%y/y) unless stated

Latest

Q4 2019

Q1 2020

Q2 2020

Q3 2020

2019

2020

2021

2022

GDP

-3.8(-3.3)

+0.1(+1.0)

-3.8(-3.3)

-20.0(-22.5)

+12.0(-13.5)

+1.2

-12.0

+10.0

+1.8

Household Spending

+0.1(+1.2)

+0.1(+1.2)

-3.0(-2.2)

-18.5(-20.5)

+8.2(-14.4)

+1.3

-12.0

+6.9

+1.8

HICP (%y/y)

+0.4 (Apr)

+1.0

+1.1

-0.1

-0.7

+1.2

0.0

+0.7

+1.0

Unemployment Rate (%)

7.4 (Mar)

7.4

8.0

15.7

12.8

7.6

12.0

10.0

9.0

Depo Rate, end period (%)

-0.50

-0.50

-0.50

-0.50

-0.70

-0.50

-0.70

-0.70

-0.70

10 yr. Ger. Bond Yield, end period (%)

-0.49

-0.19

-0.46

-0.45

-0.35

-0.19

-0.25

-0.25

-0.25

$/euro, end period

1.09

1.12

1.08

1.09

1.10

1.12

1.10

1.05

1.05

£/euro, end period

0.90

0.85

0.87

0.89

0.88

0.85

0.88

0.81

0.81

Sources: Bloomberg, Capital Economics


Jack Allen-Reynolds, Senior Europe Economist, jack.allen-reynolds@capitaleconomics.com

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