Despite worrying inflation: the ECB is keeping its feet still for the time being

The economy in the euro area is experiencing an unprecedented shock from the corona pandemic. Nevertheless, Europe's monetary authorities are not increasing their emergency purchase program for the time being. The risks for the economy remain high.

Inflation is in the basement, the economy in the euro area is experiencing an unprecedented shock, and the euro is gaining strength – but Europe's monetary authorities are not stepping up for the time being. As part of its emergency purchase program, the European Central Bank (ECB) is still investing 1.35 trillion euros in government and corporate bonds until at least the end of June 2021, as the central bank in Frankfurt announced. The ECB Council left the key interest rate in the euro area at the record low of zero percent.

The central bank is concerned about the current strength of the euro. "We have to watch the matter closely," said ECB President Christine Lagarde. The central bank no longer assesses the further economic development in the euro area as bleak as it did in June. The monetary authorities continue to expect an unprecedented recession this year. "It is a crisis like never before," said Lagarde. In its base scenario, the central bank is currently assuming a decline in gross domestic product (GDP) of 8.0 percent. In June, the monetary authorities had forecast a drop of 8.7 percent.

Europe's monetary authorities are in anti-crisis mode

According to the latest forecast, the economy in the currency area of ​​the 19 countries will grow by 5.0 percent in 2021 (June forecast: 5.2 percent). In view of the economic downturn, the central bank still needs significant support from monetary policy. The billion dollar emergency purchase program PEPP (Pandemic Emergency Purchase Program) is expected to be exhausted, affirmed Lagarde. Economists recently did not rule out that the ECB could expand purchases again until the end of the year.

The central bank's securities purchases help states and companies alike: they do not have to offer such high interest rates for their paper if a central bank is a big buyer in the market. At the beginning of June, the monetary authorities had almost doubled their purchase program by 600 billion euros to 1.35 trillion euros. The minimum term was extended by half a year. According to the central bank, inflation is likely to be a meager 0.3 percent this year, as predicted in June. The main goal of the ECB is a balanced price level with a medium-term inflation rate of just under 2.0 percent. However, inflation has been well below this target for a long time. Europe's monetary authorities have therefore been in anti-crisis mode for years.

Falling consumer prices are a potential risk

The central bank's other bond purchase programs, which had been running with interruption since March 2015, had already reached a huge volume at a good 2.9 trillion euros at the end of August. During the corona crisis, the trend towards weak inflation rates intensified. In August consumer prices in the euro area fell for the first time since 2016. According to an initial estimate by the Eurostat statistics office, the inflation rate fell to minus 0.2 percent. According to the ECB, this is an outlier – among other things because of the temporary VAT cut in Germany.

ZEW expert Friedrich Heinemann described the ECB's wait-and-see attitude as serious: "The fact that an inflation rate plummets in a historically unique crisis is nothing more than a snapshot." Heinemann does not currently consider it necessary to expand the PEPP emergency purchase program. "Even if the markets are constantly calling for more monetary expansion, it is wise not to give in to it all the time."

Basically, falling consumer prices are a potential risk for the economy. They can trigger a downward spiral as consumers and businesses speculate on further falling prices and push investments further and further back. The stronger euro can also depress inflation. This makes imports into the common currency area cheaper. At the same time, exports to countries outside the euro area are becoming more expensive. That can dampen demand.