ECB expands PEPP by €600 billion

On Thursday, the European Central Bank announced they would support their PEPP (Pandemic Emergency Purchase Programme) with an extra €600 billion, beating most analysts’ expectations of €500 billion, taking the bond-buying stimulus package to €1.35 trillion in total.

It was also mentioned the scheme would be extended to June 2021 and interest rates would be unchanged with the ECB’s Deposit Facility Rate at -0.5%, meaning commercial banks will be charged that rate annually for leaving their cash at the central bank. The interest rate on the main refinancing operations and marginal lending facility, remain at 0% and 0.25% respectively.

In addition, maturing principle payments from purchased assets under the scheme would be reinvested until at least the end of 2022 or as stated by the Governing Council, until it “judges the coronavirus crisis phase is over”.

Christine Lagarde remarked the decision would bring inflation “significantly closer” to its “pre-Covid” path. She went on to say that the two key purposes of PEPP is to act as a “backstop” with recent “short-term stress” and also to aid the economy in recovering from the coronavirus pandemic.

The ECB forecasts the eurozone’s economy to contract by 8.7% this year, before rebounding to 5.2% in 2021 and 3.3% in 2022. However, notably Lagarde said that if there were a second wave of infections then the number this year could rise to 12.6%.

Shortly after the announcement, the yield on Italy’s 10-year government bond fell 14 basis points to 1.42%, with similar falls in the yield of Spanish, Greek and Portuguese debt.

The spread between the 10-year Italian and German bonds, a closely monitored indicator of the euro area’s risk sentiment, tightened, plunging to 171 bps, its lowest level since late March.

The euro gained a fresh boost against the dollar of the back of the move and has continued its incredible 8 day rally reaching a near 3-month high of $1.1384. However, there is mixed sentiment amongst traders as to how long this may last.

Nomura’s Jordan Rochester has “high conviction” on EUR/USD and suggested traders re-position and long the pair, whilst quantitative models from Société Générale are indicating the euro is the number one G10 currency traders should be willing to bet on.

On the contrary, there remain many bears. ABN Amro’s senior FX strategist Georgette Boele expects “difficult discussions” are on the horizon for the EC (European Commission) and their stimulus scheme, and so traders should be uncertain on a “strong continued rally”. Petr Keptra, a strategist at ING, has stated how the “ECB-induced euro rally is running out of steam” and that rises or declines in the exchange pair will focus more so on the dollar’s trend, rather than central bank action.

This is particularly relevant now, as this afternoon we witnessed extraordinary numbers on U.S employment, as non-farm payrolls rose to 2.509 million in May compared to analyst estimates for a 7.5 million fall, putting a dent in recent euro strength.