The European Central Bank scrapped most of the bond-buying limits in its 750 billion-euro ($819 billion) pandemic emergency program, in a landmark decision that massively boosts its firepower to fight the economic fallout from the coronavirus.
Government bonds rallied across the euro area after the ECB released a legal document that said the issue limits, which constrained sovereign bond-buying to a third of each of its member state’s debt, “should not apply” to its new program.
Purchases started on Thursday, and the ECB said it will “explore all options and all contingencies to support the economy to counter this extraordinary shock.”
The program, scheduled to continue until at least the end of 2020, will also include bonds with shorter maturities than under its ongoing quantitative-easing operations.
Short-dated Italian debt saw the biggest gains, with two-year yields dropping as much as 15 basis points to 0.18%. German 10-year yields fell to as low as -0.37%. Greek bonds, which will be included in PEPP after being shut out of quantitative easing until now, extended their rally.
“The Eurosystem will not tolerate any risks to the smooth transmission of its monetary policy in all jurisdictions of the euro area,” the ECB said in the legal document.
The dramatic move tallies with President Christine Lagarde’s comment that there are “no limits” to the central bank’s commitment as the economy faces a deep recession due to restrictions intended to stem the spread of the coronavirus.
Former President Mario Draghi weighed in with a commentary in the Financial Times on Wednesday urging public authorities not to worry about rising debt levels, arguing that the “the cost of hesitation may be irreversible.”
European Union leaders are poised to offer political cover to the ECB’s unprecedented actions.
“We support the resolute action taken by the European Central Bank to ensure supportive financing conditions in all euro area countries,” leaders are poised to say in a joint communique, following a video conference on Thursday afternoon, according to a draft of the statement seen by Bloomberg.
Central banks globally have stepped up with extraordinary measures to fight the crisis. U.S. Federal Reserve Chairman Jerome Powell made a rare televised interview appearance on Thursday, stating his institution is “not going to run out of ammunition.”
The ECB’s Governing Council agreed the Pandemic Emergency Purchase Program in an unscheduled late-night conference call a week ago, and the legal details had to be finalized before it could be launched.
“In a nutshell, the decision removes virtually all constraints on asset purchases, in a further boost to the credibility of the ECB’s commitment,” Frederik Ducrozet, global strategist at Bank Pictet & Cie. in Geneva, said in a note. “Asset purchases can now continue well into 2021.”
While the institution is set to buy more than 1.1 trillion euros of bonds this year, questions were raised about whether the scope of its purchases could run into the self-imposed limits. Some policy makers have opposed easing the constraints, arguing it would amount to the ECB bankrolling governments.
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“When deciding on the PEPP, it was communicated and the program itself stated that the ECB would be flexible in its own parameters,” Lithuanian central bank Governor Vitas Vasiliauskas told reporters. “I believe that this spirit that was laid out in the Governing Council’s decision on the PEPP must be maintained.”
By scrapping restrictions, the ECB has effectively reduced the need for its most powerful instruments, the Outright Monetary Transactions program designed under Draghi in 2012.
OMT would allow the ECB to buy nearly unlimited quantities of an individual nation’s sovereign debt, whereas PEPP must ultimately make purchases proportional to the relative size of each economy.
But is contingent on countries securing access to Europe’s bailout fund and is typically tied to conditions. EU leaders are set to discuss access to the bailout fund when they hold a call on the political response to the pandemic on Thursday.
Both programs allow the ECB to push down bond yields that risk making much-needed fiscal stimulus unaffordable, but the PEPP is “better suited to cope with the current shock,” according to Berenberg economist Florian Hense.
“The ECB can now lend even more support to hard-hit countries such as Italy without the stigma that an early use of the OMT tool may have implied,” he said.