Given the market volatility of the past week or so, the US Federal Reserve recently announced that it would be slashing interest rates to near zero levels - which is as low as it can be without going negative. In addition, it also announced a $700 billion quantitative easing programme to help the economy absorb the negative effects of the coronavirus outbreak. Quantitative easing is a way for the Federal Reserve to inject money into the economy by purchasing assets: in this case $500bn in Treasury Securities and $200bn in mortgage-backed securities. This is the Federal Reserve's response to the financial crisis; which aims to significantly help mitigate the effects of its aftermath. The European Central Bank (ECB) has also intensified its efforts against the economic onslaught brought about by COVID-19 by launching a €750bn asset-purchase programme of its own – aptly dubbed the "Pandemic Emergency Purchase Programme"(PEPP). After digesting the complexities of the PEPP, many economists in the Eurozone were quick to react by stating that the ECB disappointed expectations, as it has not cut interest rates despite the Eurozone diving towards a possible recession.
However, it must be said that the PEPP has mitigated some of the criticism being levelled at the ECB for a perceived lack of impetus shown in the face of doomsday-like economic forecasts. It should not be forgotten that as of the 12 March 2020, the ECB had already unveiled measures aimed to curb the economic damage being inflicted by COVID-19. In a recent press release the Governing Council of the ECB said that it will do all that is necessary within its mandate in supporting all citizens of the euro area through this extremely challenging time. The ECB's chief economist Philip Lane also sought to reassure investors that the ECB is also there for Italy as in a blog post he said the ECB was "ready to do more" to contain any sovereign debt stress. To that end, the ECB has committed to ensure that all sectors of the economy can benefit from supportive financial conditions that enable the Eurozone to absorb this shock. Previous measures unveiled by the ECB prior to the launch of the PEPP included:
– an initial €120bn asset-purchase programme;
– a series of additional longer-term refinancing operations (LTROs) geared towards providing immediate liquidity support to banks and further safeguarding money market conditions; and
– allowing European banks to make use of capital and liquidity buffers – thereby enjoying significant capital relief.
The above, however, was clearly deemed insufficient, as the ECB has now rolled out an asset-purchase programme which is the rough equivalent of 7.3% of the Eurozone's gross domestic product (GDP).
So beyond the astronomical figures, how will this help – you may ask.
As mentioned above, an asset-purchase programme, or quantitative easing (QE), is a monetary policy by virtue of which a central bank (in this case, the ECB) purchases government and/or corporate securities (usually bonds) with the intention of injecting liquidity into the market – thereby encouraging lending and investment in times of economic struggle. In this vein, it would have been good to have some clarity as to how much of a country's debt the ECB can actually buy. Is the limit still stuck at a third, or is there more leeway in this respect?
There are several ways in which the PEPP package helps in these uncertain times, but it is also a very complex programme. For instance, as rightly pointed out by the Head of the Bank of Italy Ignazio Visco on Friday, these purchases can be "frontloaded" and may favour certain member states over others. The money may be beneficial for countries facing acute shocks but in the long term this may not be substantial. Nonetheless, as reported by the Financial Times, "this may also help shield the member states hardest hit by the pandemic from sharp rises in government or corporate borrowing costs".
With regard to the supervisory measures, the fact that the ECB's Single Supervisory Mechanism, using its discretion to go easy on lenders by, for example, suspending stress tests this year were welcomed as they remove some of the market pressure on banks.
Christine Lagarde, President of the ECB, has further confirmed that the ECB will not shy away from increasing the value of the PEPP should this be considered necessary. Lagarde's statement should by no means be taken lightly, and is testament to the trying times we are collectively living in. It should be noted that between 2014-2018, the ECB's various asset-purchase programmes yielded net purchases of securities in the region of €185bn, whereas its current asset-purchase programme – restarted as of November 2019 – was slated to conduct purchases at a monthly pace of €20bn. These figures, as substantial as they may be, pale in comparison to the ECB's efforts to rein in the COVID-19 blaze, with an estimated €3 trillion in liquidity to be doled out as a direct result of the ECB's collective refinancing operations.
In the words of Lagarde herself, "extraordinary times require extraordinary action". There are still issues which Europe's policymakers cannot solve. One of them is the compensation due to workers and their businesses in say the tourism sector, which is currently operating in the grey economy. Another is the dollar crunch and how the provision of liquidity via the standing US dollar liquidity swap line arrangement effectively work in practice.
It's a theme we'll return to in the coming days. Let's hope that the Eurogroup's coordinated action actually delivers.
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