Investment strategy
March 15, 2021
4 mins

ECB expects more balanced growth outlook while accelerating bond purchases

March 15, 2021
4 mins
Jeffrey Sacks
Head of EMEA Investment Strategy
European Central Bank Building in Frankfurt

As COVID retreats, we look for a rebound in European growth, driven by services. We remain overweight regional equities but expect a slightly weaker euro.

  • The ECB will continue its Pandemic Emergency Purchase Programme (PEPP) with a program size of €1.85 billion, with the possibility that it might be recalibrated and not used in full if conditions justify.

  • There will be a significant increase in the pace of PEPP purchases from now and into 2Q21, compared with the pace of purchases in the early part of the year. There will be increased flexibility across jurisdictions and assets. 
  • The PEPP program will run until at least March 2022, with maturing PEPP bonds reinvested until at least 2023. 
  • Targeted Long Term Refinancing Operations (TLTRO’s) will continue until at least mid-2022.
  • Policy rates were left unchanged, with the deposit rate at -0.5%, the marginal rate at 0.25%, and the refinancing rate at 0.0%.
  • GDP growth projections are unchanged with 4% expected this year and 4.1% next year. The inflation projection for 2021 has been revised higher to 1.5%, however is expected to fade in early 2022. 
  • After the announcement European bonds particularly in the periphery rallied strongly. Equities and the Euro were steady.

Today’s announcements and press conference statement from ECB President Ms Lagarde are broadly dovish, positive for risk appetite, and particularly supportive for periphery bonds. While there will be no yield curve targeting, the ECB aims to sustain favourable financial conditions through more aggressive bond purchases over the next quarter. The GDP growth upturn should gather momentum over the year, with ongoing vaccine progress as well as fiscal support, which should underpin the corporate earnings upturn and steady stockmarket rise. 

Growth: Europe’s real GDP growth fell by 6.6% last year. After the third quarter rebound, GDP was still 4.9% below the pre-pandemic level at the end of 2020. The Covid lockdowns are suppressing growth in the current quarter, however a rebound should gather momentum over the rest of the year led by the services sector.

The ECB’s GDP growth forecast for this year of 4% is unchanged and is in line with our own forecast. The upturn is likely to be uneven by country and between goods and services. Next year should be 4.1% assuming ongoing policy support as well as ongoing global growth along with a global trade rebound.

Inflation: The ECB forecasts are higher than their December 2020 forecasts. For 2021 the inflation rate is expected to rise to 1.5%, driven by technical and transitory factors, for example the German reversal of its VAT reduction and the higher oil price. However in the medium-term, the forecast is only 1.2%, with no wage pressure, subdued demand, and a persistent output gap.

Market rate rises: The ECB concern is that if rate rises are sizeable and persistent, there could be premature tightening and be a risk to wider financing conditions. This prompted the decision to be ‘significantly’ more aggressive with the implementation of the PEPP over the next quarter, and it appears this is being done to prevent tightening conditions rather than responding to tightening conditions. Over the course of the PEPP programme we expect the ECB balance sheet to increase to at least Euro 7 trillion.

Fiscal support: In support of the ECB measures, Ms Lagarde stressed the importance of the national ratifications of the EU’s Euro 750 billion Recovery Fund, as consumers remain cautious and corporate investment remains weak.

Covid-19 vaccines: Johnson & Johnson’s vaccine has won clearance on Thursday from the European Union’s drug regulator, the European Medicines Agency. The EU has purchased 200 million doses of the vaccine, with an option for 200 million more. Denmark, Norway and Iceland have suspended use of the Oxford/AstraZeneca vaccine as a ‘precautionary’ move after a Danish woman died with blood clots following inoculation.

Authorities have said no conclusions can be drawn on whether there was a link between the blood clots and the vaccine. Despite the slow vaccine start and ongoing challenges, we expect European herd immunity by the late summer. 

Market response to ECB announcement 

Equities: Remain overweight. 

European stock markets are holding their small gains today. The 34% move in the Stoxx 600 index since the end of October 2020 has taken the index back to where it was a year ago at the start of the pandemic. This has largely discounted the economic rebound we expect over the summer months. 

Nevertheless beyond that we expect a sustained economic recovery into 2022, making the important assumptions that vaccine progress will gather momentum, and that the EU and national fiscal expansions will continue. This should reflect in another year of strong earnings growth next year, after 31% this year, and that is not discounted yet. We could see some consolidation around current levels, before the market makes new highs.

Ownership levels remain low, with perception only improving very slowly (and not helped by the slow vaccine rollout). The valuation multiple remains at a 6.4% discount to the global average, and the yield gap versus fixed income is very likely to lead to ongoing equity inflows.

Leadership is likely to be in cyclical areas like energy, materials and industrials, that are benefitting from the stronger global growth and trade outlook. We also continue to recommend undervalued areas like banks, up 18% so far this year however still cheap in valuation terms, mostly strong capital ratios supporting dividend payments later this year, and slightly steeper yield curves supporting net interest margins. 

Bonds: Remain underweight sovereign bonds, selective opportunities in corporate bonds.

The big strength today is in periphery bonds, driven by the ECB announcing greater flexibility as well as more aggression in their bond buying programme. The Italian 10y sovereign bond  yield fell 8bp to +0.59%, Portugal’s 10y sovereign bond yield fell by 5.9bp to +0.18%, Greece’s 10y sovereign bond yield fell by 5.8% to +0.77%, and t Spain’s 10y sovereign bond yield fell by 5.7bp to +0.29%. There are further price gains ahead for the periphery, supported further by the EU Recovery  Fund grants and  with the credible ex-ECB head Mario Draghi now the Italian PM.

While developed sovereigns also rallied (the 10y German bund yield fell 2.6bp to -0.34%), we remain cautious, given the certainly of losing capital if held to maturity. While today’s ECB statement did not explicitly expand their bond buying programme into corporate high yield bonds, we anticipate continuing ‘trickle-down’ demand  to be supportive, potentially driving average high yields down another 50bp to around 2.5%.

Euro: Likely to weaken

While the Euro is steady today, we are expecting weakness versus the USD to around 1.18 over the next 6-12 months, as the growth differential and real yield differential are both moving in favour of the USD. In addition positioning in the Euro is currently quite extended. In the longer-term the low Eurozone breakup risk should be supportive. 

The most significant short-term driver of the cross-rate with Sterling is likely to be vaccine progress. The Euro is likely to drift lower against Sterling as the UK’s vaccine rollout has been much more impressive and likely to lead to an earlier growth pickup.


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