Eurozone March 19, 2020 / 10:43 am UTC

ECB: "Whatever It Takes" Second Act

By Giacomo Pallaro, Andrew Wroblewski

Bottom line: In a bid to correct a gross communication error by ECB President Christine Lagarde, the Governing Council announced on March 18 that it will launch a new Pandemic Emergency Purchase Programme (PEPP) worth €750 billion. PEPP enjoys extra flexibilities compared to other ECB’s programs and is meant to show that the Central Bank is indeed ready to do “whatever it takes” to preserve the euro, including closing spreads when the Eurozone economy faces economic shocks. While this is positive, fiscal policymakers need to do more, too.

Figure 1: Widening BTP-Bund 10y Yield Spread (top half: 10 year yields; bottom half: BTP-Bund spread)

Source: Bloomberg

Remedying a Communication Error

At the March 12 ECB scheduled press conference, Lagarde was asked if the measures then being unveiled were her ‘whatever it takes’ moment, repeating the commitment to ensure the euro’s continuation made by her predecessor Mario Draghi in 2012. She gave the opposite impression when she suggested that it is not the ECB’s job to close yield spreads. After the strong, negative markets’ reaction, several Governing Council members tried to correct her communication mistake with little success. So, in order to quell volatile markets and widening spreads, on March 18, the ECB launched another emergency package of measures that is notable for size and the potential of much greater and needed flexibility. This is on top, and not instead of, the March 12 package.

Welcome PEPP

Indeed, the so-called PEPP has an overall envelope of €750 billion, includes all the asset categories eligible under existing Asset Purchase Programmes (asset-backed securities, covered bonds, corporate bonds and public sector bonds) and is temporary in nature, with net purchases to be conducted until the ECB judges that the COVID-19 crisis phase is over, but in any case not before end-2020. Perhaps most notable, purchases under the new PEPP will be conducted in a flexible manner, thereby allowing for fluctuations in the distribution of purchase flows over time, across asset classes and among jurisdiction. Furthermore, in an added sign of being more flexible, eligibility requirements have been waived to allow the purchase of Greek government securities, which are currently not eligible under the Public Sector Purchase Programme (PSPP) due to its sub-investment grade rating.

A further advance is that the range of eligible assets under the Corporate Sector Purchase Programme (CSPP) is expanded to include non-financial commercial paper, making them of sufficient credit quality eligible for purchase under the program. This is similar to a Fed initiative unveiled this week, but the Eurozone market for commercial papers is smaller than the U.S. one.

Moreover, the ECB is showing that it is honing its support of the company sector. It decided to ease collateral standards so that banks can now borrow from the ECB posting as collateral claims related to the financing of the corporate sector. This underscores in the ECB’s direct rhetoric, highlighting that it is committed to playing its role in supporting all citizens of the euro area through this extremely challenging time. To that end, the ECB will ensure that all sectors of the economy (families, firms, banks and governments) can benefit from supportive financing conditions that enable them to absorb this shock. 

Sending a Clear Message

To avoid any possible doubt on whether the ECB will continue to do “whatever it takes” to preserve the euro, including compressing spreads via additional net purchases, in its press statement the Governing Council stressed it will do everything necessary within its mandate. This includes increasing the size of its Asset Purchase Programmes and adjust their composition, by as much as necessary and for as long as needed. It will explore all options and all contingencies to support the economy through this shock.

Highlighting its desire to show added and needed policy flexibility the Bank ended by stating specifically that the “extent that some self-imposed limits might hamper action that the ECB is required to take in order to fulfil its mandate, the Governing Council will consider revising them to the extent necessary to make its action proportionate to the risks that we face.” These self-imposed issuer and issue limits (i.e. not purchasing more than 33% of a single issue or issuer) are a concern for the PSPP, with the stock of German bonds running dangerously close to the limit. Considering a revision of issuer and issue limits is extremely important and a significant step toward further up-scaling of net asset purchases in the future. 

However, self-imposed issuer and issue limits are not the only constraints on the ECB’s purchase activity. Indeed, it remarked in the press statement that the benchmark allocation across jurisdictions will continue to be the capital key of the national central banks. This means that purchases will be guided to converge to the capital key on a stock basis. Looking at the PSPP, current stocks already show deviations from capital keys (excluding Greece). While fluctuations in the distribution of purchase flows for PEPP is flexible, it will still be guided by capital keys. Thus, added flexibility may not be as ample as thought if the ECB sticks to its rules.

Now Over To Fiscal Policy

These new measures are thus most welcome, especially for an EZ bond market whose recent bruising was becoming dangerous. It is no panacea for the EZ economy at the moment as it will not prevent the ongoing hole in demand from enlarging. That, as we and the ECB have repeatedly said, is something better addressed by fiscal policy and coordinated action, which so far has been insufficient. In this regard, it is suggested that Member States are discussing whether and under what conditions the €500bn European Stability Mechanism could be used to support EZ economies as they grapple with the current, deepening downturn. A generalized support from the ESM, perhaps with ECB’s funding, to all Member States hit by COVID-19 would avoid the stigma associated with asking for help and prevent sharp correction in bond prices, which could possibly cause countries to lose market access.

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I, Giacomo Pallaro, the lead analyst certify that the views expressed herein are mine and are clear, fair and not misleading at the time of publication. They have not been influenced by any relationship, either a personal relationship of mine or a relationship of the firm, to any entity described or referred to herein nor to any client of Continuum Economics nor has any inducement been received in relation to those views. I further certify that in the preparation and publication of this report I have at all times followed all relevant Continuum Economics compliance protocols including those reasonably seeking to prevent the receipt or misuse of material non-public information.