The outcome of the ECB’s monetary policy meeting was in line with expectations.

The ECB conveyed a confidence in its narrative of a recovery, notably in the manufacturing sector, while the language on inflation was not alarming, despite continued low inflation projections.  

Bunds sold off 2bp initially, while the EURUSD jumped on headlines saying that the ECB agreed that there was no need to overreact to the euro gains.

Confident – no need for PEPP discussion today

Lagarde struck a relatively confident tone on the economic outlook, with an upbeat tilt. An expansion of the PEPP envelope was not discussed. No change in PEPP today, yet only 1.3% inflation forecast in 2022 could have warranted another PEPP calibration given that they are not set to reach the target in 2022.

The fiscal push mentioned for revising core inflation higher in 2022, see more below, means that the ECB will ultimately rely on other policy areas to achieve the target. Thus the ECB’s monetary policy stance is important as part of the fiscal dominance agenda we have in Europe now.

‘We do not target the exchange rate’

In light of the high uncertainty on the recovery pace and duration, President Lagarde also stressed that the ECB will continue to carefully assess incoming information, including developments in the exchange rate and its impact on the inflation outlook.

That said, at the current stage the ECB did not seem too concerned about the anti-inflationary effect of the recent euro appreciation and did not see it as an immediate trigger to adjust policy. This is in line with our view, as we have argued in Euro Area Research – Escaping the exchange rate curse, 4 September 2020.

Downplaying the importance of FX

Ahead of the ECB, the focus has been on comments related to 1) EUR-strength, 2) macro forecasts and 3) Fed’s FAIT. We continue to expect a new test of 1.20, seeing 1.23 in 3M.

As expected, the impact of FX was downplayed in Q&A. Lagarde did say they had discussed FX’s impact on inflation but we take note that she did not mention they had concluded it was a major factor as such.

This may be especially so as EUR strength is a natural consequence of more upbeat macroeconomic projections. We expect the debate about where spot is fixing and how it may affect ECB communication to subside from here on.

Looking ahead, upgraded macro forecasts and still few details about the strategic review leave EUR/USD to be set by the big picture for 2021.

We continue to see a global recovery, activity at a pre-COVID level by mid-2021, a Brexit resolution and fairly benign global political situation (e.g. trade). Thus, risks appear tilted to the upside in EUR/USD and next week’s Fed meeting will likely provide a test of 1.20 in spot.