Most analysts expect the European Central Bank on Thursday (4 June) to beef up its emergency bond-buying scheme with hundreds of billions of euros to weather the coronavirus pandemic, providing governments with the breathing space to decide their own response.
While some policymakers have called on the ECB to abandon its self-imposed limits on buying government debt to stoke growth and inflation, the meeting of governors on Thursday is the first since Germany’s Constitutional Court ruled that the central bank’s powers should be reined in.
“Rarely has the case for the ECB to scale up its monetary stimulus been as strong as it is right now,” said Berenberg bank economist Holger Schmieding.
Schmieding and many other analysts predict governors will boost the €750 billion Pandemic Emergency Purchase Programme (PEPP) decided in March by a further €500 billion.
But with only around one-third of the existing corporate and government debt-buying ammunition used up by 31 May, any announcements on Thursday “will count more as a signal than a genuine economic stimulus,” he added.
“Still, signals count, especially in times of heightened uncertainty.”
ECB board member Isabel Schnabel reiterated last week that the “size but also the composition and duration” of PEPP could all be increased, with some analysts forecasting an extension from the end of this year to September 2021.
As well as possible policy moves on Thursday, eyes will be on the latest quarterly growth and inflation forecasts from ECB staff, as January-March figures were compiled before the virus struck.
ECB chief Christine Lagarde last week predicted that the eurozone economy would contract by between 8 and 12% in 2020, before an anticipated strong rebound next year.
Inflation in the 19-nation eurozone slowed to just 0.1% year-on-year in May from 1.2% in February before the pandemic and way below the ECB’s target of close to, but just below two percent.
The inflation rate outlook could fall as low as zero across the year, analysts at Capital Economics predicted, potentially offering a powerful justification for further measures to support activity and push inflation up towards the bank’s goal.
Meanwhile, the euro’s growing strength against the dollar is creating a headwind for exports.
Governors meet less than a month after a German Constitutional Court (GCC) ruling that a €2.6 trillion bond-buying scheme launched in 2015 may not have been “proportionate” to its price stability goal and needed to be clarified.
If the ECB cannot satisfy the judges, the German Bundesbank, the central bank, may not be able to participate in bond-buying.
While finding a face-saving solution to the immediate legal headache, policymakers must also consider how court challenges might limit their future options.
Bank of France governor François Villeroy de Galhau last week said the so-called “capital key” — under which the ECB buys countries’ bonds in line with their stakes in its capital — is an “uncalled-for constraint”.
Free of such limits, the central bank might choose to buy more Italian, French or Spanish debt to keep financial conditions on an even keel across the eurozone.
But the self-imposed capital key rule was also drawn up to avoid just the kind of legal dilemma that has arisen in Germany.
“While I do not think the ECB will be deterred by the GCC, I also think they do not necessarily want to raise the stakes by blatantly going against its worries,” Oliver Rakau of Capital Economics told AFP.
“An official dropping of the capital key is likely fairly controversial at this stage.”
ECB governors will also be aware that long-awaited help on the fiscal front remains far off, as leaders are just getting started debating a €750 billion pandemic recovery fund proposal from the European Commission.
While Germany this month abandoned some of its red lines in a deal with France, including on the emotive question of joint debt issued from Brussels, a so-called “frugal four” group including Austria and the Netherlands are fighting a rearguard action.
Short of joint measures, market fears of an eventual breakup of the eurozone could resurface, the ECB warned last week.
But tied into the EU’s always hotly contested budget negotiations and calls for bloc-wide taxes on plastics and big tech to fund borrowing, it will be a challenge for governments to seal the deal even by a January deadline.