Is there life after PEPP?

Key points

• Biden may arrive quite “empty handed” at COP26
• Exploring US inflation dynamics – again
• Villeroy de Galhau’s latest speech offers some insight into a “post-PEPP bond marke

The European Central Bank (ECB) governing council is busy preparing the next phase of its monetary policy when, in all likelihood, announcing in December that Pandemic Emergency Purchase Programme (PEPP) will not survive the winter. We have been intrigued by press reports these last two weeks suggesting the central bank is mulling a “third programme”, between the Pandemic Emergency Purchase Programme (PEPP) and the Asset Purchase Programme (APP), which would address bond market disruptions – read “peripheral spreads widening” – as PEPP is terminated, through discretionary interventions on selected national markets. We are very circumspect about such a concept, reminiscent of the ill-fated Securities Markets Programme (SMP) in 2010. This would make the ECB far too powerful if it could on its own extend or withdraw bond market support to member states without a clear “conditionality contract”. Ultimately, the ECB would be torn between accusations of intervening too late if it did not approve of the policy course of a member state, or symmetrically of being too complacent with adventurous governments if it felt compelled to intervene anyway to stop contagion. We think that the proposals made by Banque de France Governor Villeroy de Galhau in a speech last week to extend to APP some of the flexibility of PEPP would deal with a potential post-PEPP “withdrawal syndrome” much more efficiently.

But before turning to European monetary policy and with COP26 looming, we look at the headwinds blowing against the US administration’s determination to advance concretely on decarbonization. A key plank of Biden’s platform is the Clean Electricity Payment Programme (CEPP), which is under direct threat given the opposition of West Virginia Democratic Senator Joe Manchin. We think the alternatives – boosting and prolonging the tax credit for renewables – are sub-optimal primarily because CEPP was the closest possible substitute to proper carbon pricing in the US.

We also continue to explore inflation dynamics in the US. The September batch brought fodder for doves and hawks alike, between the deceleration in the price of the items affected by the microchip shortage and the reopening, and signs that the shock is spreading to a wider array of sectors. We continue to think that the impact of base effects is under-stated.