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GRAPHIC -Divisions over bond buying: Five questions for the ECB

Dhara Ranasinghe and Saikat Chatterjee
·4-min read

By Dhara Ranasinghe and Saikat Chatterjee

LONDON, April 19 (Reuters) - Internal divisions over the pace of bond buying, extended COVID-19 lockdowns and potential delays to the EU recovery fund form the backdrop to Thursday's European Central Bank meeting.

Sovereign bond markets may have calmed down since February's sell-off, but markets want more clarity about stimulus plans once an economic recovery takes hold.

Here are some key questions on the radar for markets.

1. How committed is the ECB to keeping bond yields in check?

The pace of bond buys under the Pandemic Emergency Purchase Programme (PEPP) has increased. Weekly PEPP purchases averaged 14.4 billion euros ($17.24 billion) in the first eight weeks of 2021 and 16.9 billion euros in the four weeks after the March meeting, notes Capital Economics.

Some bond analysts say the pace is disappointing, while minutes from the March meeting signalled divisions within the central bank. Policymakers debated a smaller increase in purchases and then agreed to front-load this quarter's buying on condition it could be cut later.

Dutch central bank head Klaas Knot believes the acceleration is temporary. ECB Vice President Luis de Guindos has said the bank will act if a rise in borrowing costs is unwarranted, adding that removing stimulus too early was a bigger risk than acting too late.

Speaking to Reuters on Wednesday, ECB President Christine Lagarde said the economy was still standing on "crutches" and stimulus could not be withdrawn.

"Lagarde will be asked whether the broad consensus to step up purchases was that broad after all," said Pictet global macro strategist Frederik Ducrozet.

2. What bond market gauges is the ECB following and how have they performed?

Lagarde said recently that bond investors appear to have understood the ECB's goal in expanding bond purchases last month -- an indication the ECB is content with a retreat in inflation-adjusted yields.

Nominal bond yields and GDP-weighted yields, one measure that ECB chief economist Philip Lane monitors, have also fallen.

Lagarde may be pressed on which indicators the ECB follows and their recent performance.

"What kind of levels does the ECB have in mind? Lagarde was saying the other day markets shouldn't mess with the ECB but its recent actions don't back this up," said Nick Kounis, head of financial markets research at ABN AMRO.

3. What about the economic outlook?

Since the March meeting, big economies such as France and Germany have extended lockdowns to combat a third wave of COVID-19, delaying recovery prospects.

Germany's economy is expected to have shrunk in the first quarter and expectations that restrictions will extend beyond mid-April have dampened hopes for a swift rebound in the euro zone's biggest economy.

However, vaccinations are picking up, euro zone business activity returned to growth in March and the International Monetary Fund just upgraded its 2021 euro zone growth forecast to 4.4% from 4.2%.

Lagarde may strike a balanced tone, since markets could interpret any upbeat comments as a sign that the pace of bond purchases will be eased.

4. Isn't it too early to talk about tapering when inflation prospects remain weak?

Inflation has risen steadily and could exceed the ECB's near 2% target in the coming months. Euro zone inflation was 1.3% in March and market-based inflation expectations have reached their highest since early 2019.

Lagarde may reiterate Lane's view that the jump in inflation is driven by transient factors and underlying trends remain weak, so the ECB must therefore maintain aggressive stimulus.

5. How worried is the ECB that Germany's ratification of the EU Recovery Fund has been stopped?

An emergency appeal at Germany's constitutional court has stopped the ratification of the EU's 800 billion euro Recovery Fund. Any delays could pressure the ECB to support the economy with more stimulus.

The ECB's Isabel Schnabel has warned that attempts to block the Recovery Fund would be an "economic disaster for Europe".

Bond yields in peripheral Europe, which stands to benefit the most from the fund, have begun to creep higher. ($1 = 0.8351 euros)

(Reporting by Dhara Ranasinghe; Graphics by Saikat Chatterjee; Editing by Tommy Wilkes and Ana Nicolaci da Costa)