The European Central Bank (ECB) could expand its bond-buying program by a further 1 trillion euros ($1.12 trillion) over the next two to three years as inflation takes center stage, according to Berenberg European Economist Florian Hense.
The central bank earlier this month increased its Pandemic Emergency Purchase Programme (PEPP) by 600 billion euros to a total of 1.35 trillion euros in a bid to shore up the economy against the fallout from the coronavirus pandemic.
In a note Friday, Hense said that while the market broadly anticipates one more expansion of the PEPP envelope by around 500-600 billion euros, the ECB could deliver a total increase of between 800 billion and 1.6 trillion euros, depending on the inflation outlook, the success of the ECB's long-term loans, and the currently paused monetary policy strategy review.
The unprecedented scale of asset purchases has succeeded in soothing financial markets following a historic downturn as the coronavirus spread throughout the world, and Hense anticipates that it will now have to turn its attention to inflation.
Hense identified the most important decision at the ECB's Governing Council meeting earlier this month as the linking of the 600 billion euro PEPP increase explicitly to the "pandemic-related downward revision to inflation over the projection horizon."
"Linking the PEPP increase to the inflation downgrade is a clear sign that the ECB has shifted its focus from short-term crisis management towards supporting the economic recovery over the medium term," Hense said.
"It has managed to stabilize markets very effectively, but returning to the 'pre-Covid inflation path' is a different matter, though – and one that will take effort and time."
The ECB's June 2020 projections suggest that after a 1.2% rise in 2019, euro zone consumer prices may only rise by 0.3% in 2020 and by 0.8% in 2021. Hense expects that with inflation well below the ECB's target of close to, but below 2%, further policy easing will be needed to support growth and facilitate a faster incline in consumer prices.
"The 1.3% forecast for 2022 is the lowest projection for the medium-term inflation since December 2014 (judging by the ECB's quarterly projections, the 2022 annual projection has been rounded up from 1.25%)," Hense highlighted, adding that core inflation could well be stuck below 1% throughout the forecast period.
Although recent policy measures by the ECB, along with fiscal stimulus from individual governments and the prospective EU-wide recovery plan, will have a positive effect on inflation, Hense said, it is only a matter of time before the central bank comes up with more.
"The ECB's own research on previous asset purchases suggests that the June decisions may have only a small impact on inflation," Hense suggested.
"The current inflation projections may still be too optimistic. If so, the ECB would need to do more than it already plans in response to its June downgrade of inflation."
Although acknowledging that highly supportive fiscal policy may add to price pressures more than in past crises this time around, he added that the extraordinary financing needs of governments will still require very favorable financial conditions.
"Eventually, the ECB will likely take further steps to maintain its very loose monetary stance for quite a while. Most of its instruments are maxed out," Hense argued.
"As a result, further envelopes of asset purchase commitments will remain the first line of action. Whether the ECB would make these asset purchases under PEPP or the more standard asset purchase programme (APP) would not matter much for the inflation outlook."
'You ain't seen nothing yet'
Speaking to CNBC on Monday, MBMG Managing Director Paul Gambles echoed Hense's sentiments, and said further monetary stimulus should be expected on a global scale for the foreseeable future, likening the U.S. Federal Reserve to "a man with a hammer looking for nails everywhere."
"This is not 1974, it is not 'stagflation,' it is not the oil crisis, it is Bachman-Turner Overdrive — 'You Ain't Seen Nothing Yet'," Gambles told CNBC's "Squawk Box Europe."
"Stagflation" refers to a state in which inflation and unemployment are both high, with stagnant demand in the economy.
Gambles suggested that markets should start getting accustomed to stimulus packages on a "shock and awe" scale if they are going to have the necessary economic effect.
"Where in the past we used to talk about $100 billion then we started talking about a trillion, we don't think it is that long before we start talking about programs that are tens of trillions of dollars," he concluded.