June 5, 2020
The European Central Bank’s (ECB) additional monetary stimulus appears synchronized with the European Union’s planned unified-fiscal policy expansion.

What Happened

At its scheduled monetary policy meeting, the ECB revised economic growth and inflation projections downward for the Eurozone. The Eurozone’s real GDP growth was moved lower to -8.7% in 2020 and is expected to partly recover in 2021 at 5.2% and in 2022 at 3.3%. Unemployment is expected to reach above 10% by 2021. Due to lower aggregate demand and energy prices, inflation expectations were downgraded close to 0%, which is significantly lower than the ECB’s preferred inflation level of 2%.

In response to continued deterioration of economic and financial market conditions, the ECB announced plans to increase the previously announced Pandemic Emergency Purchase Program (PEPP) by €600b ($680b) to €1.35t ($1.5t).

The PEPP program is designed to purchase sovereign bonds, including bonds from countries that were excluded in the past like Greece and corporate debt to provide relief to European corporate debt markets.

The purchase program’s timeline was extended to at least the end of June 2021, and the bank commits to re-invest coupons and principal payments until the end of 2022.

Our Take

The upgrade of the PEPP is appropriate and timely. Crucially, the increase in bond purchases is €100b higher than the market’s expectations. European economies still face a significant struggle ahead. The ECB’s economic projections may have to be adjusted downward again if Europe’s summer tourism disappoints already muted expectations.

Additional ECB purchases could tighten sovereign bond yields even further, which is a critical barometer for peripheral Eurozone countries like Italy, Spain, and Greece.

The ECB’s decision coincided with Germany’s additional €130b stimulus announcement and the European Union’s joint European Recovery Fund plan. The European Recovery Fund is an important milestone for Europe. For the first time, the European Commission will issue bonds to raise assets for a Recovery Fund, sharing risk collectively with all member countries and distributing a significant portion of the Fund as grants to countries in need. Negotiations continue and are expected to finalize before the end of the summer. If the Recovery Fund gets established and ECB provides significant liquidity to raise required assets, Europe could recover faster than anticipated.

Bottom Line

With global macroeconomic data continuing to disappoint, countries, especially in Europe, were required to introduce additional fiscal stimulus packages. On the monetary side, central banks committed to providing liquidity where it is needed. There are still many unknowns related to Covid-19’s spread and the containment efforts. Still, the good news is that fiscal and monetary backstops are catching up to reality and in many parts of the world could offer significant stimulus when economies are fully functioning again.

European assets have been on a recovery path along with all other global assets and would be further assisted by broad-based support for the European Recovery Fund. Given the extreme underperformance of the region in recent years, European assets could offer more upside versus other developed market assets for short-term oriented tactical investors. However, aging populations, lower expected long-term productivity and lack of a true fiscal union are strong impediments to European economic growth and related assets in the long run.

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