PEPP Talk from the ECB

PEPP Talk from the ECB

What the latest actions taken by the European Central Bank mean for European market liquidity.


At today’s ECB meeting, the Governing Council took several additional measures geared at avoiding or at least limiting a potential credit crunch. First, financing for the forthcoming edition of the targeted longer-term refinancing operations (TLTRO III) became even more advantageous, especially for banks that reach established net lending goals. Second, temporary non-targeted pandemic emergency financing operations (PELTROs) were introduced to support liquidity conditions and, in theory, provide unlimited short-term funding.

Regarding the key topics the market has recently fixated on, however, the ECB did not budge: both the size and eligibility criteria for the various asset purchase programs remain unchanged for now. According to ECB President Christine Lagarde, those program changes were not explicitly discussed by the Governing Council. That said, she mentioned very explicitly, including in the post-meeting statement, that the Pandemic Emergency Purchase Program (PEPP) can be increased, extended beyond 2020 and its composition can be adjusted.

The last part of this message can be understood to indicate either that the ECB could ignore the capital key which guides the proportionality of purchases across jurisdictions and serves currently as the fundamental ex-post constraint for the PEPP, or that the ECB will consider the addition of more eligible assets below investment-grade (Greece is already eligible for purchases under the PEPP). We tend to think that the latter interpretation is probably closer to the truth. This was supported by Lagarde’s elaborations in the virtual press conference. Either way, we very much welcome the publication of more granular data for the PEPP activities, which would be more in line with the other asset purchase programs.

The ECB could possibly broaden the pool of eligible assets by introducing a “fallen angel provision” similar to the one set up recently for collateral eligibility.
Andreas Billmeier

We were somewhat surprised by Lagarde apparently shutting the door to buying assets under the ECB’s Outright Monetary Transactions (OMT) programme after a country borrows from the European Stability Mechanism (ESM) and thereby becomes eligible in principle. She stressed that the instrument was conceived in 2012 under different circumstances, that there was no automaticity in the first place and that the PEPP was the appropriate instrument for the current situation (i.e., a symmetric shock). While COVID-19 is indeed a symmetric shock, we think that the impact is not, and some countries are harder hit than others. As such, we view the statement today as a push back to what has been discussed within the Eurogroup and the European Council: borrowing from the highly rated ESM is just that—cheap financing—but not another way to have the ECB pick up the tab.

Given how explicit the ECB was in terms of flexibility around the PEPP, we expect the ECB to expand that program at a subsequent meeting, potentially as early as June. The ECB could also possibly broaden the pool of eligible assets by introducing a “fallen angel provision” similar to the one set up recently for collateral eligibility. With asset purchases geared toward Italy currently and for the foreseeable future, an extension of the program is, at some point, the only way to continue purchases of Italian bonds while still respecting the capital key ex post. 


Definitions:

COVID-19 is the World Health Organization's official designation of the current novel coronavirus disease.

The European Central Bank (ECB) is responsible for the monetary system of the European Union (EU) and the euro currency.

The Eurogroup is an informal body where the ministers of the euro area member states discuss matters relating to their shared responsibilities related to the euro.

The European Stability Mechanism (ESM) is a permanent rescue funding program to succeed the temporary European Financial Stability Facility.

A fallen angel is a bond that was rated investment-grade but has since been downgraded to junk status due to the declining financial position of its issuer. The bond is downgraded by one or more of the big three rating services.

The Governing Council of the European Central Bank is the main decision-making body of the European Central Bank (ECB) and has "sole responsibility" for formulating monetary policy in the Eurozone.

Under the Outright Monetary Transactions (OMT) or bond-buying program, the European Central Bank (ECB) would offer to purchase eurozone countries’ short-term bonds in the secondary market, adding liquidity to the financial system.

A pandemic is the worldwide spread of a new disease.

The Pandemic Emergency Purchase Programme (PEPP) is a €750 billion ECB initiative that will be conducted until the end of 2020 and will include all the asset categories eligible under the existing asset purchase programme (APP).

PELTROs consist of seven refinancing operations that begin in May 2020 and expire, in a staggered sequence, between July and September 2021.

Targeted longer-term refinancing operations (TLTRO) is a program of the European Central Bank designed to provide liquidity to the financial sector. In TLTRO III, similarly to TLTRO II, the interest rate to be applied is linked to the participating banks’ lending patterns. The more loans participating banks issue to non-financial corporations and households (except loans to households for house purchases), the more attractive the interest rate on their TLTRO III borrowings becomes.

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