Europe leaves stimulus running hot ahead of recovery

FRANKFURT, Germany — The European Central Bank left its key pandemic support for the economy running full blast even as the economy shows signs of recovery thanks to lower virus cases and fewer restrictions on activity in the 19 countries that use the euro currency.

The bank expects “a sizable improvement” over the second quarter of the year, ECB President Christine Lagarde said Thursday after the decision was released. But she cautioned that the rebound “continues to depend on the course of the pandemic and how the economy responds after reopening.”

Lagarde downplayed inflation that has ticked higher recently, saying it was the result of temporary factors and an increase energy prices. She said there was still “significant economic slack” holding back underlying inflationary pressures.

The central bank for the 19 countries that use the euro said in its policy statement Thursday that emergency bond purchases would remain at “a significantly higher pace” over the coming quarter than during the first three months of the year. That mirrored language from its last meeting on April 22, changed only to extend the higher pace of purchases by a quarter.

While economic activity is picking up, Europe is not expected to reach pre-pandemic levels of output before 2022, well behind the US and China.

The ECB has been purchasing around 85 billion euros per month in government and corporate bonds as part of a 1.85 trillion euro ($2.25 trillion) effort slated to run at least through early next year. Purchases were stepped up in March amid lagging vaccinations and high COVID-19 case numbers.

The purchases drive up the prices of bonds and drives down their interest yields, since price and yield move in opposite directions. That influences longer-term borrowing costs throughout the economy, sending them lower.

That’s exactly what the bank wants at a time when many companies are struggling with reduced demand, higher debt and the need to keep credit lines open so they can get to the other side of the pandemic.

IHS Markit’s surveys of purchasing managers showed activity increasing sharply in May, including for the hard-hit services sector. The index reached 57.1, with anything over 50 indicating expansion. Statistics for economic output in the first quarter were revised up to minus 0.3% from minus 0.6%; the ECB expects a strong rebound in the second half of the year and growth of 4.0% for all of 2021.

Rising inflation also complicates the ECB’s messaging. Normally, rising prices would lead a central bank to withdraw its stimulus. But in this case, ECB officials and economists say recent higher inflation figures are the result of temporary factors that will fade, leaving inflation below the ECB goal.

Eurozone annual inflation hit 2.0% in May due largely to rising energy prices. The ECB’s goal is less than, but close to 2%. The base comparison to lower energy prices during the pandemic year 2020 will soon drop out of the statistics, however, meaning post-pandemic inflation could be weaker than current figures might otherwise suggest.