The European Central Bank made no changes to monetary policy at this month’s meeting as policymakers wait and see how the Eurozone’s recovery evolves. The size of the ECB’s new quantitative easing Pandemic Emergency Purchase Programme (PEPP) was kept at EUR1.35 trillion and its deposit rate remains at -0.50%.
Chart 1: Economic Activity, Eurozone
Source: Bank of Singapore, Bloomberg
The EUR rallied, however, hitting 1.19 against the USD before giving up some of its gains. First, the ECB raised its GDP forecasts though it still expects a severe contraction of -8.0% for 2020 followed by a rebound of 5.0% in 2021. As Chart 1 shows, economic activity has fallen far more this year than during the 2008 financial crisis. Forward looking indicators are rebounding, however, as Chart 2 shows, enabling the ECB to wait and see if its PEPP bond buying is sufficient to keep the Eurozone’s recovery on track.
Chart 2: Eurozone Confidence & German IFO
Source: Bank of Singapore, Bloomberg
Second, the ECB did not signal it would take any significant action in the near term to counter the sharp summer rally in the EUR.
The currency has appreciated from 1.12 in June to 1.20 earlier this month against the USD after the European Union approved a new Recovery Fund and the Federal Reserve shifted to a more dovish stance of average inflation targeting.
The ECB meeting statement did warn it was monitoring the impact of the exchange rate’s appreciation on inflation: ‘in the current environment of elevated uncertainty, the Governing Council will carefully assess incoming information, including developments in the exchange rate, with regard to its implications for the medium-term inflation outlook.’
But President Christine Lagarde did not signal the ECB will take stronger action if the EUR keeps rising. The central bank head only repeated the ECB’s view that it ‘stands ready to adjust all its instruments, as appropriate’ rather than stressing it would cut its deposit rate further into negative territory from -0.50% to curb EUR strength.
The lack of more forceful signals on the exchange rate combined with the ECB revising its 2020 GDP forecasts higher keeps the EUR on track to reach our one year forecast of 1.25 against the USD. We expect the ECB will expand its PEPP bond buying in December given weak inflation but without any cuts to the ECB’s -0.50% deposit rate, the single currency’s uptrend will continue over the next 12 months.Disclaimer applicable to recommendation
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Version: July 2020