The ECB May Have To Raise PEPP By EUR 300-400bn In June

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BofA Global Research | We cut our Euro area GDP forecast to -8.3% this year and +4.6% next. The recovery will be weak, permanent income losses big. Fiscal stimulus is not enough to boost consumers and capex. Deficits will still be very big, c 17% cumulatively in 2020/21. The Franco-German initiative helps sentiment earlier than growth. ECB help will remain crucial. PEPP has to double, at least.

This time, we cut 2H20

We cut our Euro area GDP growth forecasts to -8.3% this year (from -7.6%) and 4.8% next year (from 8.3%). The story is simple: lockdown and reopening progress as expected, but fiscal policy still falls short of needs. That means pressure on corporates, hence on capex. High levels of unused labour (unemployed or short-time work schemes), households take precautions by saving. The perfect mix for an incomplete recovery.

Too little, and maybe also too late, from policy

The 8% permanent income loss in our scenario would require an 11-12% discretionary fiscal impulse to compensate. That compares with the 3-4% currently announced, plus maybe 4% via the Franco-German recovery plan from 2021 onwards. That is not to say the Franco-German proposal is not powerful – on the contrary. It is a strong message, helping EU cohesion and keeping existential threats at bay. It is just a bit small and late.

Funding needs will be large

Too little fiscal stimulus still means large deficits of around 9-12% this and 6-10% next year. Option 1: sufficient stimulus, bigger deficits, better long-term growth. Option 2 (current trajectory): insufficient stimulus, less growth, more burden from contingent liabilities. Either way, the ECB will have to help keep financing conditions intact.

The ECB will have a busy time ahead

The ECB will have to stay very active. PEPP will be a function of the economic shock. We stick to our call that it will ultimately have to double (at least) and stretch into next year. Late summer would be good timing to keep the EU Council on its toes. But market stress after the German court ruling forced fast-paced purchases. If maintained, the ECB may have to raise PEPP by EUR 300-400bn in June, with a promise of more to follow.