ECB keeps rates unchanged, continues bond buying at 'higher pace'

FRANKFURT -- The European Central Bank (ECB) said on Thursday that it will keep the euro area key interest rates unchanged and will continue buying bonds under its Pandemic Emergency Purchase Programme (PEPP) at a "significantly higher pace" over the coming quarter than in the first months of this year.

Eurozone key interest rates will remain at record low levels, with the base interest rate, marginal lending rate and deposit rate unchanged at 0.00 percent, 0.25 percent and minus 0.50 percent, respectively, the ECB said in a statement.

The central bank also said that "the Governing Council expects net purchases under the PEPP over the coming quarter to continue to be conducted at a significantly higher pace than during the first months of the year," echoing the decision in March that bond buying will pick up pace to ease worries over rising bond yields.

The PEPP, first rolled out in March last year to cushion the impact from the pandemic and expanded twice thereafter, has a total envelope of 1.85 trillion euros (2.25 trillion U.S. dollars) and is set to run until at least the end of March 2022.

The ECB said it will purchase "flexibly according to market conditions" and with a view to preventing "a tightening of financing conditions."

FORECASTS REVISED UP

ECB President Christine Lagarde said that the Governing Council has been "more optimistic about the economic outlook than three months ago," pointing to the bright side of the region's economy as the society is reopening and the vaccination campaigns are making significant progress.

"We expect economic activity to accelerate in the second half of this year as further containment measures are lifted," Lagarde told journalists on Thursday, adding "A pick-up in consumer spending, strong global demand and accommodative fiscal and monetary policies will lend crucial support to the recovery."

Recent data signal a bounce-back in the services activity, which accounted for about 60 percent of the area's total economic activity. The manufacturing sector continues to recover, although supply-side bottlenecks could pose some headwinds in the near term, Lagarde noted.

The ongoing pandemic, including the spread of virus mutations, and its implications for economic and financial conditions, continue to be sources of downside risk, she added.

Overall, in an updated forecast on Thursday, the ECB staff foresee the euro area annual real GDP growth at 4.6 percent in 2021, 4.7 percent in 2022 and 2.1 percent in 2023. Projections for both 2021 and 2020 were revised up from three months ago.

Meanwhile, euro area headline inflation has been surging. Annual inflation is expected to increase from 1.3 percent in March to 2.0 percent in May, the highest in nearly three years, overshooting the ECB's long-standing price stability target of "close to, but below, 2 percent."

Lagarde noted that the recent surge was "largely on account of base effects, transitory factors and an increase in energy prices." She expected the headline inflation to rise further in the second half of the year before declining as temporary factors fade out.

"Headline inflation is expected to remain below our aim over the projection horizon," Lagarde added.

Taking into account the latest data, the ECB staff now expect euro area annual inflation to stand at 1.9 percent in 2021, 1.5 percent in 2022 and 1.4 percent in 2023. The outlook has been revised up for 2021 and 2022 and is unchanged for 2023.

"STEADY HAND" ON STIMULUS

Lagarde also told journalists that there was "some debate" about the bond purchase decision but in the end policymakers all came to support the policy approach which she described as "steady hand."

The ECB president stressed that bond purchases under the PEPP will be conducted flexibly according to market conditions, "which clearly include seasonality."

In a macro-economic analysis, Lagarde said financing conditions for firms and households have remained broadly stable since the March meeting, but market interest rates have increased further.

"While partly reflecting improved economic prospects, a sustained rise in market rates could translate into a tightening of wider financing conditions that are relevant for the entire economy," noted Lagarde.

When asked about the exit of the PEPP, Lagarde reiterated that at this stage it is "too early, premature and unnecessary" to discuss those longer-term issues and these issues had not been discussed by the Governing Council.

"The ECB must remain expansive for longer," Marcel Fratzscher, head of the Berlin-based German Institute for Economic Research, wrote in an online comment. To emerge from the pandemic and stay competitive globally, European companies in particular will need favorable financing conditions for a long time in order to make necessary investments, Fratzscher said.

Fratzscher noted that the fear of too high inflation is "a very German phenomenon" and "unfounded," adding that inflation expectations for the coming years will be well below the ECB's price stability target.

"Inflation that is permanently too high would only arise if the economy overheats. Europe and Germany are currently a long way from that," Fratzscher said.