Euro Area Policies: Staff Report for the 2020 Article IV Consultation with Member Countries—Supplementary Information

2020 Consultation on Common Euro Area Policies-Press Release; Staff Report; and Statement by the Executive Director for Member Countries

Abstract

2020 Consultation on Common Euro Area Policies-Press Release; Staff Report; and Statement by the Executive Director for Member Countries

1. Recent developments and data releases are in line with staff expectations regarding the outlook and balance of risks. New data indicate that the strong rebound in real GDP (12.5 percent, q/q) in 2020Q3 was largely driven by household consumption, with a total contribution of about 7 percentage points. Investment, net exports, and public consumption also contributed positively. Employment and working hours rebounded in 2020Q3 by 1.0 and 14.8 percent (q/q), respectively. As for 2020Q4, industrial production (SA, excl. construction) rose by 2.1 percent (m/m) in October, while the number of new reported infections in the euro area was halved to about 80,000 per day in mid-December relative to early-November. Nonetheless, given concerns about pandemic dynamics over the holiday period, countries continue to apply stringent containment measures, and some have even expanded them (e.g., Germany and the Netherlands). Relatedly, mobility indicators remain well below the summer months, suggesting that output is likely to contract in 2020Q4.

2. The ECB Governing Council’s decision on December 10 to extend the duration and scale up the volume of several monetary policy instruments was welcome. Reflecting a weaker inflation outlook, the ECB’s Governing Council recalibrated several of its monetary policy instruments to provide a bridge through a longer-than-expected pandemic phase, which was widely anticipated by markets after the November meeting:

  • The Pandemic Emergency Purchase Program (PEPP) was increased by €500 billion to €1,850 billion and its duration extended by nine months to at least the end of March 2022 (from June 2021). In addition, maturing securities will be reinvested until at least end-2023 (previously, end-2022).

  • The parameters of targeted longer-term refinancing operations (TLTRO-III) were modified, including by extending the period over which banks can secure favorable terms through June 2022 and increasing the borrowing limits. Moreover, three additional operations will be conducted between June and December 2021, while the April 2020 collateral easing measures were extended to June 2022.

  • Four additional pandemic emergency longer-term refinancing operations (PELTROs) will be added in 2021 to act as a liquidity backstop. The Eurosystem repo facility for central banks (EUREP) and all temporary swap and repo lines with non-euro area central banks have been extended to March 2022.

This recalibration of monetary policy instruments is consistent with the staffs call for continued monetary policy accommodation. Nevertheless, it remains the case that further accommodation could prove necessary, especially if downside risks materialize.

3. On December 15, the ECB lifted its restriction on banks’ distribution of dividends in 2021. Nine months after the ECB ordered banks to cease all dividends and share buybacks to conserve €30 billion of capital in March, the ECB decided to allow the region’s strongest banks to resume dividend payments within strict limits if their capital buffers are sufficient to absorb expected loan losses.

4. EU leaders reached a compromise to finalize the agreement on the EU budget and recovery package on December 11. The dispute about the rule-of-law mechanism, which threatened to derail approval of the 2021–27 EU budget and Next Generation EU recovery package, was resolved following an agreement to exclusively rely on rulings of the European Court of Justice before triggering sanctions towards countries accused of rule-of-law breaches. The European Council and European Parliament now need to take steps to adopt the relevant legislation, including the Own-Resources Decision, which must also be ratified by member states’ parliaments.

5. European Leaders agreed on critical reforms of the European Stability Mechanism (ESM) treaty, notably the introduction of a common backstop for the Single Resolution Fund (SRF). The backstop will take the form of a credit line from the ESM and will replace the Direct Recapitalization Instrument. It is expected to be operational at the beginning of 2022—one year earlier than initially planned—contingent on the ratification of the revised ESM treaty by all 19 member states’ parliaments.

6. EU-U.K. negotiations on a post-Brexit trade deal are ongoing, but agreement has been reached on how to implement the Northern Ireland Protocol. The remaining areas of negotiation on the post-Brexit trade deal are level playing field provisions, a fisheries agreement on access to waters and quota shares, and governance. Regarding the Northern Ireland Protocol, the agreement in principle reached in December 2020 covers the implementation of customs controls, application of state aid rules, exemptions for certain goods and activities, and dispute resolution. With this deal, the U.K. government has indicated it will drop clauses in the draft Internal Market Bill that could have been subject to legal challenge.