The current focus of the European bond market is the potential evolution of European Central Bank policy. ECB programs have been a key driver of the economy and financial markets over the past several years, and even contributed to the survival of the Eurozone in difficult periods like last year, when the ECB supported government public deficits by launching its Pandemic Emergency Purchase Programme (PEPP).
But with the manufacturing cycle now appearing sturdy, it’s an open question if the ECB will start to taper the amount of its PEPP bond purchases at its June meeting.
The PEPP program was designed to fight against the consequences of COVID-19 in the Eurozone; as the pandemic is now under control in the wake of the vaccination rollout acceleration since April, the ECB will likely want to reduce purchases, but we expect it will wait for further confirmation on the economy and financial conditions, after the summer. There are still major uncertainties:
- The threat of the new COVID-19 strains and resulting economic impacts.
- Financial conditions have been tighter since the March meeting, and the ECB does not want to give a hawkish signal that could further tighten them.
- Although service sectors are reopening, the ECB would like to confirm that an activity rebound recreates jobs.
- The pace of a recovery in inflation rates and the ability of the ECB to support a gradual and sustained rise in inflation rates.
In light of these issues, ECB members who have spoken recently have been uniformly dovish in tone, downplaying any expectation of reducing the pace of bond buying at the June meeting. Even the most hawkish members have spoken in a more neutral way than usual.
At the coming meeting, we expect the ECB to announce more flexibility linked to financial conditions. Over the summer months, with lower issuance and less market liquidity in fixed income markets, the ECB should “practically” reduce the pace of its purchases. However, a larger or more hawkish signal is not likely until at least this fall.
To access our views on the Fed tapering conversation, be sure to take a look at my colleague Olumide Owolabi’s latest NB Blog.