The European Central Bank confirmed the dovish bias of its new strategy, shifting towards a “quasi” outcome-based approach
The ECB modified its forward guidance regarding interest rates, alleviating, inter alia, concerns that could tighten policy prematurely and aligned it with the new Monetary Policy Strategy, where the Governing Council agreed a symmetric inflation target of 2%.
The ECB expects the key interest rates to remain at their present (DFR: -0.5%) or lower levels until i) it sees headline inflation reaching 2% well ahead of the end of its projection horizon; ii) headline inflation projection is “durable” for the rest of the projection period, thus it cannot go significantly below 2%; and iii) progress in underlying (core) inflation is sufficiently advanced to be consistent with inflation stabilizing at 2%, perhaps running close to 1.5%-1.75%.
President Lagarde noted that “well ahead” is essentially the midpoint in overall projection horizon, currently until the end of 2023, meaning in practice 12-18 months. In all, the new guidance signals accommodation for longer than in the old framework. Euro area periphery sovereign bond spreads narrowed modestly post ECB, with GGBs and BTPs trading in a tight range of 100 basis points over Bunds since May 2021.
The broader inflation outlook remains subdued despite the underway, mostly transitory, increase. Given current ECB forecasts, with headline and core HICP inflation at 1.4% in 2023, the above conditions for liftoff are very challenging to be met.
Regarding Quantitative Easing, President Lagarde dismissed any discussion regarding the end (or modification) of its pandemic emergency programme (PEPP) as premature. Recall that net purchases under the PEPP with a total envelope of €1.8 trillion (current holdings of €1.25 trillion) is expected to last, at least, until March 2022.
The ECB reiterated its expectation for maintaining a “significantly higher” pace of PEPP purchases over Q3:2021 compared with the first months of 2021 (average €14 bn per week). Net purchases under the APP will continue at a monthly pace of €20 billion (current holdings: €3.02 trillion).
Attention now turns to the Fed meeting on July 28th and on how the “talking” about QE tapering (US Treasuries and agency MBSs), evolves. The Fed is expected to strike a balanced tone, acknowledging concerns regarding the rapid spread of the COVID-19 delta variant, while noting the risks of high inflation being more persistent than expected.
At the same time, the advance estimate for real GDP in Q2:2021 is due on July 29th, with consensus expecting growth of 8.7% qoq saar (12.7% yoy) from 6.4% qoq saar in Q1. US growth is expected to slowdown in H2:2021, albeit remaining above trend.
Developed equity markets (S&P500, Nasdaq, Stoxx600) ended the week at new all-time highs as risk sentiment was supported by the ample central bank stimulus and stronger-than-expected earnings results. So far, roughly 28% of the S&P500 has reported, and 85% have beaten earnings estimates versus a 5-year average of 75%. Investors will get further insight into earnings and spending plans as more results arrive, including reports from Apple, Amazon, and Microsoft due this week. Recall that consensus analyst expectations for S&P500 EPS growth in Q2:2021, stand at +76% yoy.