Can the PEPP improve the euro area’s financial health?

19 March 2020

Chris Scicluna

With questions increasingly being raised about its commitment to do “whatever it takes” to counter the economic and financial impact of COVID-19, and the associated threat to the future of the euro itself, earlier tonight the ECB announced a new temporary asset purchase programme, the Pandemic Emergency Purchase Programme (PEPP). In particular:

  • The PEPP will amount to €750bn with purchases to be conducted until the end of the year. Added to the €120bn of purchases committed under the existing Asset Purchase Programme, under the new plans the ECB will now purchase on average almost €100bn per month until the end of 2020.
  • All asset classes eligible under the existing asset purchase programme (APP) will be included, i.e. public sector bonds, corporate and covered bonds, and asset-backed securities.
  • In terms of the public sector purchases, the capital key will nominally still be the benchmark for allocation across jurisdictions. Crucially, however, the purchases will be conducted “in a flexible manner” to allow “fluctuations in the distribution of purchase flows over time, across asset classes and among jurisdictions.” As such, the capital key is no longer a binding constraint to prevent the ECB from increasing purchases of BTPs (or any other member state’s bonds).
  • The ECB also committed to revising any of its self-imposed limits on the public sector bond purchases (i.e. the 33% issue and issuer limits) if they would prevent the ECB from buying assets to the extent necessary to achieve its mandate.
  • In addition, for the first time, Greek government bonds will be incorporated in the ECB’s asset purchases in the PEPP.
  • In terms of the corporate bond purchases, the ECB took a lead from the Fed and BoE and will now, for the first time, include non-financial commercial paper, an important source of funding for many companies. The collateral framework will also be adjusted to incorporate claims related to the financing of the corporate sector.

Overall, therefore, the announcement of the PEPP brings the response of the ECB closer in line with that of the Fed in terms of its magnitude and scope. And coupled with the recent increase in fiscal commitments over the past couple of days, the euro area macro policy response is starting to look a little bit more fit for purpose. But only time will tell whether it is commensurate to the task in hand. As the full magnitude of the shock underway will only be evident over time, much more support from the ECB and governments might yet be required.

The greater flexibility within the PEPP should, however, at least allow the ECB, should it so wish, to relieve the pressure on Italian and Greek bonds that harmful comments on Thursday from Lagarde, and yesterday from the Austrian Governor Holzmann, had generated. But to allay the doubts about its commitment, the ECB will still need to demonstrate that flexibility by driving Italian and Greek spreads significantly lower from the get-go when euro area bond markets reopen this morning.

If not, the other euro area authorities might not want to stop contemplating an ESM bailout for the two most heavily indebted southern member states. And the issuance by governments of a common euro area ‘coronabond’ would still be the ideal counterpart to the PEPP. That, however, still seems likely to remain on the drawing board.

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