Quantitative easing

SPEECH

Euro area: economic outlook and financial stability during the pandemic crisis

Remarks by Luis de Guindos, Vice-President of the ECB at the Institute of International and European Affairs, Dublin, (by video conference)

• Economic activity declined in the first quarter by 3.6 percent, quarter-on-quarter, driven by the fall in both domestic and foreign demand.
• Consumer spending plummeted, largely due to the shutdown of non-essential businesses and heightened uncertainty about job prospects.
• Although employment declined only by 0.2 percent, quarter-on-quarter, in the first quarter of the year, recourse to national employment schemes remained at unprecedented levels.
• At the same time, business investment is expected to have collapsed on the back of lockdowns, fading demand, increasing uncertainty and vanishing liquidity.
• In May, survey indicators suggested that there were some signs of the slump bottoming out alongside the easing of containment measures.
• Although the euro area economy remains in a deep contraction, consumer and business confidence indicators improved in May.
• In order to achieve a broad-based recovery, national measures must be backed up by forceful action at the European level.
• The inflation projection is also subject to unprecedented uncertainty, with a faster recovery in the mild scenario.

Financial markets

• Euro area financial markets were set in turmoil as the virus spread throughout Europe: euro area sovereign bond spreads widened, corporate bond spreads surged and stock prices plummeted.
• Financial markets eventually stabilised, notably on the back of a forceful monetary policy response by the Eurosystem.
• An effective pass-through of risk-free rates to sovereign bond yields in all countries is crucial because sovereign bond yields are widely used as benchmark rates for pricing financial market instruments and bank credit.
• Evidently, the costs banks face to raise funding in the money, capital and equity markets have notably increased.

Monetary policy measures

• Tightening financial conditions, combined with an outlook for price stability that had significantly worsened due to the economic fallout of the COVID-19 crisis, prompted the ECBs Governing Council to take further policy action at its June policy meeting.
• We decided that the most effective way to respond would be to increase the size of the pandemic emergency purchase programme (PEPP).
• First, the PEPP can provide a significant degree of additional monetary easing as it directly affects the benchmark rates used to price financial market instruments and bank credit in all euro area countries.
• Second, the PEPP safeguards monetary policy transmission to all asset classes and jurisdictions thanks to the embedded flexibility in conducting asset purchases.
• Likewise, the other monetary policy measures taken in response to the pandemic such as the targeted and pandemic emergency longer-term refinancing operations (TLTRO and PELTRO programmes), will run their course through the summer of 2021.

Financial stability during the pandemic crisis

• Over the last few years, signs of asset mispricing as well as lingering private and public sector debt sustainability concerns had been identified as vulnerabilities to financial stability.
• In addition, euro area banks profitability had been low, due to both structural and cyclical factors, while non-bank financial intermediaries had grown in size since the great financial crisis, taking on more credit and duration risk.
• As the coronavirus shock hit the euro area, we observed flight-to-safety phenomena, a surge in volatility and a sharp tightening of financial conditions, as in previous crises.
• The pandemic crisis also poses considerable challenges to the banking sector.
• Let me first recall that euro area banks entered the crisis with stronger capital and liquidity positions than they had at the time of the global financial crisis a decade ago.
• Unlike in 2008, this crisis did not originate from the banking sector and banks have an essential role to play in supporting the economic recovery.
• Looking ahead, financial stability concerns will crucially depend on the shape of the economic recovery.
• Taken together, these measures should help the euro area banking system to sustain lending to households and companies while weathering losses.
• Complementing these prudential measures, government loan guarantee schemes have the potential to offset at least some of the losses.

SPEECH

The ECB’s response to the COVID-19 pandemic

Remarks by Isabel Schnabel, Member of the Executive Board of the ECB, at a 24-Hour Global Webinar co-organised by the SAFE Policy Center on “The COVID-19 Crisis and Its Aftermath: Corporate Governance Implications and Policy Challenges”

• Frankfurt am Main, 16 April 2020 The COVID-19 pandemic is a shock of unprecedented intensity and severity.
• The challenges facing all parts of the economy in dealing with the economic, humanitarian and social consequences of this crisis are historic.
• Central banks are no exception.

Addressing risks of adverse macro-financial feedback loops

• In a matter of days, the pandemic reversed the previous easing in financial conditions that was consistent with a return of inflation to our medium-term aim.
• This threatened to unleash a perilous macro-financial feedback loop that, if left unaddressed, would have put at risk the ECBs price stability mandate and endangered financial stability more broadly.
• First, to restore the orderly functioning of euro area financial markets, which suffered from an extraordinary degree of volatility, fast de-risking and thin liquidity conditions.
• In achieving these objectives, and in calibrating our response, we had one invaluable asset: our large and tested toolkit.
• Previously tested instruments also meant that our decisions could be put in place much more swiftly, accelerating our response time.
• And the third component relates to our traditional role as a lender of last resort to solvent banks.

Safeguarding the monetary policy stance

• Given the importance of sovereign yields in financial markets, a simple measure of our effective monetary policy stance is the GDP-weighted euro area government bond yield curve (slide 2, left chart).
• In the wake of the Corona outbreak, this curve dislocated perceptibly, leading to an effective tightening of the monetary policy stance.
• We observed a measurable upward movement at all tenors as well as a steepening of the curve.
• Even German Bund yields had risen by around 20 basis points over that same period.
• The announcement of the PEPP helped break this dynamic and partly reversed the steepening of the curve.
• Everywhere in the euro area, spreads relative to German Bunds fell measurably upon the PEPP announcement.
• Persistent heterogeneity in the euro area has been a long-standing concern for our single monetary policy.
• It severely complicates the conduct of our policy.
• The PEPP interrupted and reversed this dynamic, thereby safeguarding the financial conditions that are consistent with our primary mandate.

Measures in support of firms and banks

• Similar considerations guided our decisions for mitigating the impact of the crisis on the funding conditions of firms and banks, over and above the effects on the sovereign yield curve.
• [1] But since the euro area is traditionally a bank-based economy, measures supporting the liquidity in financial markets were unlikely to prove sufficient.
• They needed to be accompanied by measures that ensured that financing conditions for small and medium-sized firms would remain equally attractive.
• Together with the first component they provide a reliable backstop for firms and households during these challenging times.
• Our measures in support of bank lending, together with the loan guarantee schemes provided by governments, attempt to mitigate this friction.
• In Italy, for example, bank lending conditions for firms remained remarkably resilient in recent years despite significant swings in market-based funding conditions of the sovereign, banks and firms.
• Again, our measures can provide a valuable bridge to the future and help keep aggregate external funding costs of firms stable until the economy recovers and uncertainty diminishes further.

Macroeconomic implications of the pandemic

• ECB staff is currently assessing the extent to which the current crisis will affect the likely future inflation and growth trajectories.
• In the short run, headline inflation can be expected to drop measurably on the back of the decline in energy prices.
• The March HICP release was a harbinger of what can be expected in coming months.
• First, uncertainty around these estimates is considerable, with forecasts for next years inflation ranging from -0.4% to 2.5%.
• Any mid-point forecast therefore needs to be taken with a grain of salt.
• Second, private sector forecasts appear considerably more optimistic than the latest projections by the IMF, which sees euro area GDP contracting by 7.5% this year and predicts a markedly weaker rebound of only 4.7% in 2021.

Conclusion

• Let me conclude.
• What shape the recovery will ultimately take remains highly uncertain at the current juncture, even as authorities gradually start to ease lockdown measures in some economies.
• The ECB has responded forcefully to this historic crisis by adopting a wide-ranging set of carefully calibrated measures that collectively help mitigate the economic and financial fallout from the pandemic.
• Our measures contribute to easing financing conditions of firms and households and supporting banks in their effort to maintain viable liquidity conditions in the economy at large.

INTERVIEW

Interview with To Vima

Interview with Isabel Schnabel, Member of the Executive Board of the ECB, conducted by Angelos Athanasopoulos and published on 4 April 2020

• 4 April 2020 The ECB recently decided to unleash its firepower once more to protect the euro area economy.
• Over the past few weeks, the outlook for the economy deteriorated sharply as countries had to intensify containment measures, dampening both production and consumption.
• We also observed a sharp tightening of financial conditions at a time when the economy needed support.
• This helps stabilise financial markets, and contributes to much more favourable financing conditions, not least in Greece, where interest rate spreads have dropped markedly.
• Would you say that it is different from a typical monetary quantitative easing (QE) programme?
• We expect it to run until we judge that the current crisis is over, but at least until the end of the year.
• How do you respond to those who say that the ECB should not raise the issue limit of 33% when buying bonds?
• That being said, there is clearly a need to provide European-level support to those euro area countries hit most by the crisis.
• This is not just a question of European solidarity, but also makes sense from an economic standpoint.
• Mitigating the negative economic effects of the crisis in each Member State and supporting the recovery afterwards makes the whole of Europe stronger.
• There are other instruments that could be used, like an EU rescue fund or measures involving the ESM or the European Investment Bank.

INTERVIEW

Interview with RTÉ (Ireland’s National Television and Radio Broadcaster)

Interview with Philip R. Lane, Member of the Executive Board of the ECB, conducted by Robert Shortt on 13 February 2020 and broadcast (in part) on 13 February 2020

• 14 February 2020 There has been some criticism of ECB policy when it comes to quantitative easing and negative interest rates.
• Theres been this assertion that interest rates are no longer an effective tool for stimulating economic activity.
• If you go back to 2014, which is when this policy started, since then ECB monetary policy has been very effective.
• We would not only have lower inflation: we could even have the risk of deflation.
• And without these policies the recovery in Europe we have seen in the last five or six years would not be so far advanced.
• That was a very costly episode to have and we are intent on making sure inflation goes back to target in order to avoid that situation.
• What is true at the moment is that this episode has been going on for years now.
• We have had very low interest rates for a long time and that does have implications for the financial system and for these groups.
• Going back to the previous question, if we did not pursue these policies then the medium-term scenario would be worse.
• It is a temporary phase, but there is no doubt that there are consequences for those looking to earn income.
• But we are still in the legacy of the crisis and I think this policy path is correct.
• We also always say that, in terms of the speed of the recovery, European fiscal policymakers can do more.
• We tried that before here, and we need to keep a limit on the amount of debt that households take on.
• There is a long list of recommendations, called the country-specific recommendations that the European Commission offers to the member countries.
• Whats very interesting about the ECB is that our only focus is on the overall performance of the euro area.