'Falcons' vs 'doves' at the ECB. Lagarde will give strong signal, but tensions should postpone stimuli

The eurozone central bank is again divided between those who want more stimulus now and those who prefer to wait. Christine Lagarde has room to maneuver and should wait until December, when she has new projections and a better view on political risks. Today's message should therefore be a promise to act in the face of increased risks.

Prepare ground to announce new stimuli in December. This should be the main objective of Christine Lagarde, the president of the European Central Bank (ECB), in the message to be conveyed at the press conference after today's Board of Governors meeting, according to analysts.

"The debate on additional ECB stimulus has moved from an 'if' to 'when' question," said Nick Kounis, head of financial markets research Dutch bank ABN-Amro. "This reflects signs that the eurozone economy is losing momentum, weak underlying inflationary pressures, the second wave of the virus, new restrictions and a change in tone by members of the central bank."

For Kounis, the ECB could surprise with new measures ahead of expectations in October if it concludes that preventive action can be more powerful than being "behind the curve" in terms of shaping expectations in the financial markets. "In addition, there is a risk management argument, given that the outlook could deteriorate sharply in the coming weeks if trends in the virus do not improve and governments react by tightening restrictions considerably."

However, like most analysts, Kounis believes that the ECB should wait until the December meeting to announce the new stimulus, especially given the divergences in the Council on the strategy to follow.

"The old division"

Franck Dixmier, global CIO fixed income from Allianz Global Investors (GI), explained that “in fact, the old division between 'pigeons' and 'hawks' has reappeared, referring to previous disagreements between members of the Board of Governors who prefer a more accommodative monetary policy (the 'pigeons') and those who prefer a more conservative or conventional one (the 'hawks').

“Christine Lagarde, who defends the search for consensus, will have a lot of work ahead of her to resolve an old debate: there is a risk that an even more aggressive policy for the purchase of sovereign bonds could be seen as monetary deficit financing, something prohibited by treaties ”, he stressed.

The Allianz GI analyst says there are other factors that could favor the choice of December for new stimuli. At the December meeting, the ECB is expected to update its macroeconomic projections. "We hope they are pessimistic, so it may be a good time to announce new support measures."

In addition, at that time the central bank will have more perspective on the political risks that have emerged in recent weeks - such as Brexit and the elections in the United States - as well as on the evolution of the pandemic.

Dixmier also says that the Pandemic Emergency Procurement Program (PEPP) continues to maintain its firepower and therefore there is no urgency to act now, except to give a strong signal.

"In view of the deteriorating economic outlook and low inflation in the context of the worsening health crisis, Christine Lagarde must strongly assert her willingness to take additional monetary support measures at the end of the year," he said.

Stimulus menu

The ECB launched the PEPP in March this year to support the economy and markets to face the risks that the pandemic caused in the eurozone, initially with a value of 750 billion euros in purchases from and a deadline for this year. At the June meeting, the ECB increased the amount by 600 billion (to make up the current total of 1,35 billion euros) and extended the deadline until June 2021.

If as for timing analysts are pending an announcement in December, regarding the nature of the new stimuli there are some differences of opinion. Nick Kounis, from ABN-Amro, sees the PEPP as the central platform, as the ECB believes that the Quantitative Easing, or the purchase of assets has a greater impact on growth and inflation compared to other tools and that within the options PEPP offers greater flexibility than 'conventional' programs,

Carsten Brzeski, global head of macro of ING, on the other hand, anticipates an increase in the PSPP in December, to the detriment of one in the PEPP.

Franck Dixmier, from Allianz GI, says that the new stimulus should “include an extension of the PEPP, postponing its scheduled end from June to December 2021, and an increase in the ECB's purchase program to meet the record sovereign emissions expected in 2021. ”, Adding that it also provides for new favorable conditions for TLTROs, long-term refinancing operations aimed at supporting bank credit.

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