We expect the ECB to interpret a period of above-target inflation as “transient” even if it lasts for well over a year. Although it will end its emergency PEPP programme next March, the Bank will step up the pace of its conventional asset purchases, most likely from €20bn to €40bn per month, and leave its key policy rate unchanged at -0.5% until around 2025. It is also possible that the Bank establishes a “backstop fund” to be used in the event of an exceptional widening of credit spreads. All in all, our forecasts suggest that policy will remain very loose for longer than the markets currently anticipate, and this in turn should help the ECB to keep a lid on both core and peripheral sovereign bond yields.
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