On the 19th of February, the European and American stock market peaked before the huge sell off due to the coronavirus outbreak. On the 2nd March, the president of the ECB acknowledges in a press release that the outbreak might create “risks for the economic outlook and the functioning of financial markets” and only on the 12th it releases another statement with the monetary policy measures followed by the bottom of the European stock market 2 days later.
Usually, the first tool that central banks use when economic stimulation is needed are the interest rate cuts for short term loans and deposits with the Central Bank to increase the liquidity in the economy. The ECB has three different rates: the deposit facility (interest rate that banks receive for overnight deposits in the ECB), the marginal lending facility (interest rate that banks pay to borrow from the ECB overnight) and the MainRefinancing Operations (interest rate that banks pay to borrow from the ECB for one week). Unlike the FED, the ECB cannot make instantly a150-bps emergency rate cut because the deposit facility rate is already too negative (-0.5%) and further cuts would lead to a big devaluation of the euro.
Since most central banks in the developed countries do not have a lot of room to further cut interest rates, over the last decade they have introduced various types of asset buying programs, which is what will be discussed in this article. These asset buying programs also have a limited effectiveness and for that reason some countries have also been taking fiscal measures within their monetary policy by just giving money to people like Australia did during the 2008 financial crisis.
12th of March
On 12th March, the Central Bank announced additional LTRO (Long-term Refinancing Operations) operations to mature in June 2020. Newseries for the LTRO will occur every week at an expected interest rate of-0.5% paid at the maturity (24/6/20). Thereafter, the 4th series of TLTROIII will start.
The TLTRO III (Targeted Long-term Refinancing Operations) is a lending program of the ECB to the European banks with a maturity of three years and new series every quarter. This money is targeted to non-financial corporations and households (except loans for house purchases). It was decided that between June 2020 and June 2021, this program would have an interest rate 25 bps below the MRO rate, while the 3 key interest rates are higher and remain unchanged.
Still on 12th March, the ECB announced a “temporary envelope” of €120 Billion until the end of the year along with €20 Billion per month of net purchases under the APP (“Asset Purchase Programme”), withfull reinvestment of maturing securities. Banks will be allowed to take more risk by operating below a set of defined capital ratios.
15th of March
Later, on the 15th of March, the ECB announces coordinated US dollar liquidity swap line agreements.Without the coordination amongst major central banks* in terms of monetary policy, huge swings in exchange rates would occur which could be transferred to more volatility in the financial markets. Also, Swap lines agreements are important for the financial system because it gives to the ECB instant access to foreign currencies in exchange for euros to provide foreign currency liquidity to European banks. In a nutshell, interest rates on current swap lines agreements were decreased by 25 bps amongst these major central banks, weekly offerings were added but with an 84-day maturity (instead of the typical 1 week)and on 23th March the frequency of the swap line offerings was changed to daily. Later, more swap line agreements this time in euros were created with other smaller central banks as shown in the table.
18th of March
The measures previously described are quite common when the economy and markets face huge shocks. Although, the central banks create specific new programs for the crisis that might create controversies and have an impact in the value of the currency. Unlike the FED, the ECB only launched one program called PEPP (Pandemic Emergency Purchase Programme) worth €750 Billion. To put this number in perspective, in 2019 the ECB balance sheet was worth roughly €4700 Billion.
This program was launched on 18th of March and will only end when the euro area has a better outlook,but not before the end of the current year. These purchases are targeted to private and public sector securities that were already eligible under the APP. This program also waived “the eligibility requirements for securities issued by the Greek government”, which means that now it will be possible to buy more public debt from Greece.
A program that was already in place was the CSPP (corporate sector purchase programme) which was modified to include quality short-term commercial paper of other companies instead of just the financial sector.
Unsurprisingly, in the last 3 paragraphs of this press release the Governing Council of the ECB basically said that they will do “whatever it takes” to support the euro area, which is followed by almost an 18% increase in the Stoxx 600 index just 6 days after.
30th of April
On 22nd of April the ECB takes steps to control the impact of downgrading securities in the markets.
Later, on the 30th of April ECB Press conference, it was decided that TLTRO III would have favorable terms between June 2020 and June 2021. Throughout this period, the interest rate on this program will stay between -1% and -0.5%, which is lower than the 12th of March decision. Also, a new program was created: PELTRO (non-targeted pandemic emergency longer-term refinancing operations). This program consists of seven operations with a maturity of 8-16 months, starting in May 2020, and an interest rate 25 bps below the MRO rate (0%). Still on this day, the ECB suggests again that it will do “whatever it takes” by saying that they’re open and prepared to increase “the size of the PEPP and adjust its composition, by as much as necessary and for as long as needed.”
In a nutshell, now banks are allowed (by the ECB) to take more risk and new short-term liquidity instruments were created. These instruments will be offered more frequently (daily in some cases) and will have interest rates that could be as low as -1%. After June 2020, there are more programs with a similar interest rate in some cases but bigger maturity. In the case of swap lines, maturity was increased by 12 times (from 7 days to 84 days),which is important due to demand for the dollar by the clients of the banks. In terms of asset-buying programs the ECB launches its famous “bazooka” –the PEPP – but also increases the purchasable securities in other programs and helps to control the market shock from the downgrading of some securities. Finally, in almost every statement from an ECB meeting, it is reinforced its commitment to help the euro and its institutions.
All of these easing measures aren’t new but, according to Financial Times, since 2015 a group of 1750 Germans (mainly economists and law professors) argued that government debt monetization by the Central Bank was illegal under the EU treaty. Thus, on the 5th of May the ECB is notified by the German Federal Constitutional Court regarding the PSPP (Public Sector Purchase Programme).
All of this is explained by the fact that Germany and Germans as whole are net savers and not net debtors (like Portugal, Spain, Italy and Greece) which means that currency creation (thus currency devaluation) will affect their savings. For example, it is known that Germans are risk-averse, thus influencing its investments towards public debt for example, and have a low debt overall (62% Government Debt to GDP for example). Even its households save a lot of money (at 11.2% in January of 2020) as a percentage of their income. So, since Germany does not benefit a lot, and is actually affected, by debt monetization programs, that contributes to the euro devaluation, it is understandable why they’re so angry and went as far as the constitutional court. In the future is very likely that similar countries might join this fight like Holland.
*the Bank of Canada, the Bank of England, the Bankof Japan, the European Central Bank, the FederalReserve, and the Swiss National Bank
Article published in our May Newsletter
João Ferraz, MSc in Finance