The Governing Council of the European Central Bank (ECB) met on 4 June, keeping policy rates unchanged as widely expected: the deposit rate at -0.50%, the main refinancing rate at 0%, and the marginal lending rate at 0.25%. The ECB announced a €600 billion increase in its Pandemic Emergency Purchase Program (PEPP), from €750 billion to €1.350 trillion, citing low growth and disinflationary pressures. Net purchases were extended until at least June 2021, with the bank pledged to reinvest principal payments until at least the end of 2022.
The minutes of the meeting showed that the bank stands ready to do more if needed to containsovereign bond spreads around current levels. The minutes provided rationale for the increasein the PEPP and attempted to respond, indirectly, to the German Constitutional Court’s (GCC)ruling on quantitative easing. The GCC requested that the ECB demonstrates that its monetarypolicy is not “disproportionate to the economic and fiscal policy effects of the programme”. The ECB chief economist Philip Lane has given extensive explanations and arguments for the ECB’s measures since the pandemic started, in speeches and again noted in the minutes. There werespecific references to “proportionality”, with several paragraphs addressing the pros and cons ofasset purchases. The German parliament are to discuss the ruling in early July.
The ECB’s fourth round of targeted long-term repo operations (TLTRO) III saw a net liquidity injection of €548 billion. There was widespread participation by 742 banks, adding to positive sentiment with the increased liquidity buffers further reducing systemic risks. Combined with theECB’s asset purchases, excess liquidity in the banking system increased from approx. €2.7 trillionto €4 trillion. The outstanding TLTRO tranches benefit from the more generous terms. with ratescharges as low as -1%, if certain criteria are met.
The European Commission met on 19 June to discuss both the EU’s next seven-year budget andthe recovery fund. The proposed recovery fund totalling €750 billion, which aims to underwritethe worst-hit parts of the eurozone such as Italy and Spain, would be split between €500 billion ingrants and €250 billion in cheap loans. Although France and Germany have shown support, the“frugal four” of Austria, Denmark, the Netherlands and Sweden have signalled their resistance tohanding out too much money as grants. An article published in the Financial Times newspaperoutlined that they would be aiming for a smaller recovery fund, open for a shorter period, andbased on loans rather than grants. They are next scheduled to meet 17–18 July.
The ECB stands ready to do more if needed. The market doesn’t expect them to cut ratesfurther at this stage, but more likely to increase the PEPP purchases and perhaps innovate theTLTRO-IIIs. After suffering unprecedented economic collapse in the euro area in the first half of2020, expectations are for a rapid recovery in Q3 and onwards, as government restrictions arelifted and given the supportive fiscal and monetary policy stances. The ECB next meets on16 July 2020. Market expectations are for policy rates to move lower over time, with ten basispoints (bps) of rate cuts forecast by 2021.
The third estimate of GDP in Q1 showed the euro area economy contracted by -3.6%, quarterover-quarter (q/q). This was a larger fall compared to other advanced economies, reflecting theearlier and stricter lockdowns in Europe. For Q2, expectations are for a greater contraction in GDP, with analysts suggesting as much as a 20% fall. The ECB’s latest projections envisage the economy contracting by -8.7% in 2020, followed by a strong recovery of 5.2% in 2021 and 3.3%in 2022.
Eurozone headline annual inflation showed a small increase in June, rising 0.3% compared to Mayat 0.1%. This higher than expected outcome was due to an increase in energy prices, although theyear-on-year energy inflation rate was still well below zero at -9.4%, up from -12% in May. Food inflation was at 3%, with processed foods rising 5.9%, as households are spending more moneyon food during the lockdown. The core rate (which excludes energy, food and tobacco) fell to0.8% in June, down from 0.9% in May. The ECB expects the inflation outlook to be disinflationary,with the headline forecast at 0.3% for 2020 (down from 1.2% in 2019), 0.8% for 2021 and 1.3% for2022. These are well below the bank’s stated target of “close to 2%”.
Unemployment in the euro area increased to 7.3% in April, from a revised 7.1% in March.This was a much smaller-than-expected rise, with forecasts as high as 9% in the wake of the pandemic and lockdown. On a national level, Germany’s jobless measure rose from 5.8% in Aprilto 6.3% in May, with support from the government’s “kurzabeit” scheme limiting the increase;it is estimated that 7.3 million people are receiving wage support. The ECB’s latest projectionsfor unemployment are 9.1% for 2020 (up from 7.6% in its March forecast), 10.1% for 2021 and9.1% for 2021.
Data releases in June continued to provide further evidence of how badly the eurozone economyhas been affected by the pandemic. Eurozone retail sales fell by over a fifth from February toApril. Industrial production declined by almost a third, with France, Italy and Spain, suffering larger contractions compared to Germany. On a positive note, we are seeing some elements of recovery too, with improvements from the after the record low purchasing managers’ index (PMI) readings in April. The eurozone flash Composite PMI for June confirms that economic output is rapidly recovering as restrictions ease, although activity is likely to remain below itspre-virus levels for some time. The headline index increased from 31.9 in May to 47.5 in June,with manufacturing and services components rising by similar amounts. At the national level,the French Composite PMI was above 50 for the first time since February, at 51.3. Germany’s Composite PMI was 45.8 and expectations are for other eurozone members to be higher, helped by the massive government subsidies. The Eurozone Economic Sentiment index showed thelargest one-month improvement on record, from 67.5 in May to 75.7 in June. Although industry sentiment was aligned to expectations, services continued to disappoint, with the effects ofthe lockdowns and social distancing continuing to weigh on the hospitality sector. However, theshape and strength of the recovery beyond Q2 still remains uncertain and it is likely that theeurozone will not regain its pre-crisis levels for a long time.
Excess liquidity deposited with the ECB increased over the month, a net increase of €563 million, reaching an historic high on 29 June at €2.718 trillion. Reserves jumped by €558 million on 24 June, coinciding with the settlement of the fourth TLTRO III and the injection of cash to thebanking system. Overnight Index Average (Eonia) averaged a yield of -0.46%, remained stableover the month but moved 1 bp lower at quarter-end. Eonia, since October 2019, tracks €ESTR(the ECB’s new short-term rate) plus a spread of 8.5 bps. Hence, €ESTR was 1 bp lower,at -0.555% at quarter end.
Euribor moved lower over the month, with expectations that there would be a strong take upof the ECB repo liquidity. One-month Euribor averaged -0.49%, ranging from -0.47% to -0.51% before closing at -0.51%, approx. 3 bps lower than May; three-month Euribor averaged -0.38%, ranging from -0.33% to -0.38%, closing June at -0.42%, 12 bps points lower than May. Six-monthEuribor averaged -0.22%, ranging from -0.16% to -0.22%, closing at -0.31%, 15 bps lower than May; one-year Euribor averaged -0.15%, ranging from -0.10% to -0.23%, closing at -0.23%, 14 bps lower than May.
Euro-denominated short-dated core government bills traded lower over the month, ranging from-0.53% to -0.64%. Three-month French Treasury bills ranged -0.50% to -0.55% in June, closing at-0.52%. Overnight government repo and cash deposits were stable, between -0.55% and -0.60%. Quarter-end trading saw some pressure, with rates 5–10 bps lower.
Performance was mixed in global bond markets, with some of the longer-dated debt of the “safehaven” countries coming under pressure, but then recovering; 10-year US Treasury yields initiallymoved to a high of 0.90% on 5 June, although it ended June unchanged at 0.66%, having held ina range of 0.60% to 0.75% since late April. Ten-year German Bund yields began June at -0.40%,hit a high -0.28% on 5 June, before closing at -0.46%. In the UK, there continued to be market discussions as to whether negative rate policy will be on the agenda for the Bank of England, with BoE speakers not ruling this out, “as long as downside risk remains”. 10-year UK gilt yieldsmoved lower, beginning June at 0.23%, closing at 0.17%, with a high of 0.35%. Italian government debt continued to rise, yields moving lower and spreads tightening; its 10-year bond yield fell to1.26% at the end of June, compared to 1.47% in May. PEPP purchases up to the 26 June totalled €345.520 billion, up €30 billion from the previous week. The ECB held €10.579 billion of corporate bonds and €35.384 billion of commercial paper at the end of May.
At the fund level, the weighted average maturity (WAM) averaged 35 days in June, up from29 days in May. European money markets continued to show encouraging signs of recovery, with strong activity as investor and market confidence returned. Investments were mainly in theone-to-three month space, with selective investments out to six months. We have noticed thatcorporate issuers appear to be well-funded, with reductions or maturities not being rolled overin the money markets. Short-term liquidity ratios remained high in both overnight and one-week maturities. Fund liquidity was covered with a combination of government and agency holdings,government/supranational repo and bank deposits. Quarter-end was challenging with collateral givers and bank cash deposit takers reducing their requirements as balance sheet contractionsand regulatory requirements kicked in. As always, liquidity and capital preservation remained the key drivers for the portfolio, with yield a distant third.