/The ECB will be wary of killing the market rally as it holds fire on Thursday

The ECB will be wary of killing the market rally as it holds fire on Thursday

04 November 2019, Berlin: Christine Lagarde, President of the European Central Bank (ECB), will give the laudation to President of the Bundestag Schäuble at the “VDZ Publishers’ Night 2019

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The European Central Bank and its president, Christine Lagarde, face another crucial test this week as they hold off on any new monetary stimulus, but try not to destroy a belief that more firepower is available. 

The Frankfurt institution will likely stay put after last month’s extension and enlargement of its PEPP (Pandemic Emergency Purchase Program), which climbed by 600 billion euros ($ 686 billion) to 1.35 trillion euros.

“As (the) lender of last resort, the ECB has stabilised markets and prevented a major financial crisis which would have exacerbated the recession,” said Florian Hense, an ECB watcher at Berenberg Bank in a recent research note.

“Financial conditions have eased significantly, equity markets have surged.”

Since that decision on June 4, a number of hawkish policymakers in the region, such as Dutch central banker Klaas Knot, have questioned whether the full amount will ever be needed if the economy rebounds faster than expected.

Indeed, the ECB’s bond buying in the final week of June fell to its slowest pace since the expansion of the program, according to data released by the ECB. That could suggest some “tapering” of PEPP in the future, especially if the economy does do better than expected.

“We think it is a remote scenario,” said Hense. “Ironically, the more the ECB contemplates openly such (a) thing, the more it may have to eventually accelerate its purchases again to compensate for the negative economic consequences of the market lowering its initial expectations about the size of the stimulus to come.”

‘A little bit brighter’

The second quarter of 2020 has seen a severe drop in economic activity, but recent data actually points to a potentially less pronounced recession than previously thought.

“The outlook is a little bit brighter than it was only two months ago,” ECB Vice President Luis de Guindos said in a webinar organized by Goldman Sachs on July 8. He added that the most recent data points to “having perhaps a little bit more optimism with respect to the drop in the second quarter and the recovery in the third and the fourth.”

The recovery though is fragile. And depending on further developments regarding the spread of Covid-19, the crisis — for now — is seen as having a dampening effect on inflation.

“We expect core inflation to edge lower in the coming months, before it will gradually pick up again,” said Dirk Schumacher, an ECB watcher with Natixis, in a research note.

“This will provide the ECB with sufficient room for maneuver to announce additional purchases should this be deemed necessary.”

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