The next meeting of the European Central Bank is scheduled for Thursday and will be important because it shall review the pace of the emergency bond buying program which was boosted back in March to prevent a rise in borrowing costs hurting the recovery in the euro area. Dovish rhetoric from policymakers suggests no hurry to slow the pace of buying under the €1.85 trillion Pandemic Emergyency Purchase Programme (PEPP). Yet, with economic data improving, inflation picking up, other central banks taking tentative steps to slow stimulus and with the EU recovery fund now ready to be launched, pressure to taper is starting to build.

Most analysts expect the ECB to mantain a higher pace of buying in the third quarter given recent dovish commentary. However, the ECB could stress flexibility over purchases depending on market conditions and seasonal factors, which markets may interpret as a sign that buying could slow in August when supply of governent bonds typically falls. Others don’t rule out a modest slowdown in purchases given on going economic progress.

The PEPP will run until end-March next year and the ECB has said that it doesn’t need to use the full €1.85 trillion envelope. With the economy strengthening, the hawks in the Governing Council could make their case for not using the full amount involved. Dutch central bank chief Klaas Knot, a renowned hawk, said last week that, the European economy is recovering faster than expected from the COVID-19 shock. Nonethelesss ECB chief Christine Lagarde has stressed that the ECB would continue to support the euro zone well into its recovery.

While starting actual tapering is unlikely, Lagarde is also likely to steer clear of providing any comments that suggest a debate on tapering is even underway. She would push back such talk until after the ECB’s strategy review in September.

Inflation in the euro area surged past its elusive near 2% target in May, presenting a communication challenge for policymakers happy to live with higher prices for now. Officials believe market talk of rapidly rising prices is misplaced. While the ECB is likely to revise up near-term inflation forecasts, its long-term estimates should show price pressures remaining subdued. GDP forecasts will also be watched since they will be the first to reflect spillover effects from US President Joe Biden’s fiscal stimulus.

Dovish ECB talk has pushed bond yields down from May’s multi-month highs, reassuring the central bank. Strategists expect the upward push in borrowing costs to return, a move that shouldn’t cause alarm if accompanied by strong economic data.

March ECB minutes flagged concern about the strength in the euro. Since then it has firmed by around 1.6% versus the US dollar but current levels shouldn’t cause policymakers too much worry.

Disclaimer: This article was written by Stephen Borg, Head of Private Clients at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd and is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.

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