Eurozone Monetary Policy March 2019

Eurozone

Eurozone: ECB to buy over EUR 1 trillion of Eurozone debt this year to counteract coronavirus fallout

March 19, 2020

On 18 March, at an extraordinary night meeting after borrowing costs for Southern European countries had jumped on mounting coronavirus (Covid-19) concerns, the European Central Bank (ECB) unexpectedly decided to step up its efforts to combat the economic and financial shockwaves currently shaking the Euro area. The ECB unveiled a new EUR 750 billion Pandemic Emergency Purchase Program (PEPP) to buy public and private sector assets until at least the end of this year, as part of efforts to keep borrowing costs in check at a time when countries prepare to boost fiscal spending to cushion the impact of the coronavirus.

In a twist from ECB President Christine Lagarde’s controversial statement last week that the ECB was “not here to close spreads”, the Bank stated it will buy public sector securities using current benchmark allocation rules in a flexible manner, therefore suggesting it could temporarily buy more than a third of the outstanding debt of troubled governments like Italy. Furthermore, the Bank suggested it could even lift the aforementioned limit as well as the rule to purchase government bonds in proportion to the weight of each country’s investment on the ECB’s capital, on the ground that “the ECB will not tolerate any risks to the smooth transmission of its monetary policy in all jurisdictions of the euro area”. Moreover, purchases under the new PEEP will also include Greek government debt for the first time since the country’s sovereign debt crisis. As it stands, the Bank sent investors the clear signal it will stand behind the region’s hard-pressed governments.

At the same time, the ECB expanded the range of eligible assets under the corporate sector purchase program (CSPP) to non-financial commercial paper of sufficient credit quality, and also eased its collateral standards to allow commercial banks to raise money against more of their assets, thus supporting financing of the corporate sector. Wednesday’s package comes on top of the measures adopted in the 13 March ordinary policy meeting, which added an ‘envelope’ of EUR 120 billion of net asset purchases until the end of 2020. Therefore, the ECB will buy over EUR 1 trillion—almost EUR 120 billion per month—of Eurozone debt in the next nine months.

With its latest move, the ECB decided to open the floodgates of liquidity and at the same time lend financial support to governments’ finances ahead of fiscal stimulus. Spreads of peripheral countries narrowed markedly in the wake of the decision, suggesting markets believe the Bank’s determination to stand behind governments. However, the announced measures could raise legal concerns about overreach by the ECB in Germany, which might see them as a breach to European Union laws forbidding financing governments and decide to bring the ECB to the European Court of Justice.

The severe impact of the coronavirus outbreak on already soft economic prompted the ECB to unveil further stimulus measures at its extraordinary March meeting. Although the economy was seemingly strengthening at the outset of the year, the sudden spread of Covid-19, coupled with the drastic containment measures adopted throughout the Eurozone, has shaken economic activity and rocked financial markets. On the supply side, the pandemic has substantially disrupted supply chains, while also heightening uncertainty and thus strongly affecting spending plans and investment decisions on the demand side. Meanwhile, prospects of faltering global demand and rising global supply weighed on energy prices and prompted a drop in inflation from 1.4% in January to 1.2% in February, which thus moved further below the ECB’s target of “close to, but below, 2%”.

The regional economy will inevitably take a significant short-term hit; the duration and intensity of the impact will now depend on the length and scope of containment measures adopted by member states, the spillovers on demand plans and supply chains, as well as on the fiscal response. With regards to the latter, on 13 March Lagarde urged member states to adopt a coordinated fiscal response to the crisis, stressing that the response needed to be “fiscal first and foremost”.

Commenting on the latest ECB decision, Carsten Brzeski, chief Germany economist at ING, noted:

“In the short run, financial markets and the economy will still depend on how the pandemic and with it the preventive government measures to tackle it evolve. This will be the main determinant for the depth of the recession. The fact that the Eurozone has finally come to terms with the magnitude of the crisis should cushion the downswing and is an important prerequisite for a swift rebound. As so often in the past, it took the Eurozone (and this time around also the ECB) a while to react. The policy reactions did not come with one big coordinated swoop, but the package of government stimulus, liquidity and guarantees combined with Lagarde’s ‘whatever it takes’ as it stands right now is strong.”

Our panelists project the refinancing rate to end this year at 0.00% and 2021 at 0.03%.


Author: Massimo Bassetti, Senior Economist

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Euro Area Monetary Policy March 20 20 2

Note: ECB Refinancing Rate in %.
Source: European Central Bank (ECB).


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