Central Bank Outlook
In the recent European Central Bank (ECB) monetary policy, Christine Lagarde (President of ECB) was looking to talk down the Euro (EUR) from the highs in December 2020 as she fears low inflation rate will take a toll of the economy. A strong EUR is not becoming sustainable in the long run due to the exports from European Union to other countries becoming more expensive and also adding inflationary pressure to the European Union (EU). The EU recorded a core inflation of 0.7% month on month for the past 4 months which is way off the target of 2%. Data on the left shows that some major economies like The Netherlands and Germany have performed better than others such as Italy and Spain in the past year and the former will continue to outperform its peers in the coming years . ECB’s Makhlouf also added on saying that there is currently no need to cut interest rates, adding that the option remains a possibility if the economic outlook darkens.
We expect inflation to rise to 1% on average in 2021 from 0.2% on average in 2020 in the EU. Over the next few years, the significant slack in the labour market should translate into lower wage pressures, keeping labor costs low for companies. Downward pressure on prices will also come from lower inflation expectations and weak global demand, and we thus expect inflation to remain low, only reaching 1.3% in 2023.
The current inflation rate is still below ECB's target of 2%, meaning ECB will have to do more. Some measures will be announced in December to support the economy through a second lockdown. We expect the ECB to increase the duration of its Pandemic Emergency Purchase Program (PEPP) till the end of 2021. As a result, the ECB will need to add more money to its €1.35 trillion spent on the PEPP to ease market financing for the upcoming year.
To ensure that the tightening of credit standards reported in the last Bank Lending Survey don't derail bank lending, the ECB is likely to lower the Targeted Long-Term Refinancing Operations (TLTRO) refinancing rate by 25 basis points. This will help banks' profitability at a time when provisioning for nonperforming loans is mounting. Longer term, the low inflation outlook suggests the ECB is set to keep its monetary policy loose until at least the end of 2023.
ECB policy makers agreed at their last meeting to take a deeper look into lending dynamics to see how current stimulus measures are affecting credit, after a survey showed banks tightened standards at the end of last year amid concerns about the economy, increased credit risks of borrowers and a lower risk tolerance.
With some countries in the EU facing a second wave of COVID-19 cases, it remains to be seen how the EU manages to tackle the situation and improve their individual’s countries economy. One key concern is the Coronavirus vaccine delays risk another crisis for the European Union. EU paves way to bigger pandemic bailouts for companies. The second wave of COVID-19 is unlikely to be as disruptive to the eurozone economy as the first. Companies have learned to better operate amid the turmoil, health and safety measures are in place, and protection equipment more widely available. The latest round of lockdowns won't hit the economy at full steam this time; the containment measures haven't tightened from zero as was the case in March. Recent announcements on effective vaccines have also steadied nerves. The fatality rate is now dropping steadily from its peak.
The chart to the left shows ECB’s target level of the EURUSD chart. Lagarde hopes that once the EURUSD stabilizes around the 1.18-1.19 mark (indicated by the blue line), the EU will be able to hit its inflation target rate of 2% for the whole EU in the coming years.
In conclusion, traders trading the EUR pair should pay close attention to ECB's monetary policy especially their asset purchasing programmes (see if ECB's is cutting or increasing its asset purchasing programme) and the tone of ECB's President Christine Lagarde as she aims to talk down the EUR further. Key data such as inflation rate, consumer confidence and business confidence will be crucial to understand the direction in which the EUR will be heading towards in the coming months. Lastly, we need to observe if the debt in Spain, Greece and Italy is ballooning or shrinking in the months to come.