The European Central Bank intensified its response to the “unprecedented contraction” facing the euro area with a bigger-than-anticipated increase to its emergency bond-buying program.
At a virtual meeting on Thursday, President Christine Lagarde and colleagues decided to expand the amount of purchases by 600 billion euros ($675 billion) to 1.35 trillion euros, and extended their duration until at least the end of June 2021. The vast majority of economists surveyed by Bloomberg last week expected a boost of 500 billion euros.
Italian bonds rallied, with the yield on 10-year debt compared with the German equivalent set to narrow the most since mid-May. The euro reversed losses. European equities initially climbed on the announcement before falling back in late trade.
“Action had to be taken,” Lagarde said in a press conference. While there are nascent signs of the downturn bottoming out, “the improvement has so far been tepid.”
She revealed sweeping downward revisions to the ECB’s projections for growth and inflation in the region. In 2020, the bloc will likely see a contraction of 8.7% before rebounding by 5.2% in 2021. Under a more severe scenario with a strong resurgence of infections, output could shrink by as much as 12.6% this year.
Inflation, which Lagarde said is the ultimate justification for the ECB’s actions, will accelerate only slowly, and is seen averaging 1.3% by 2022—far below the goal of just under 2%.
The ECB action reflects how Europe is finally stepping up with powerful plans to drag the economy out of its worst recession in living memory. Germany announced a new 130 billion-euro fiscal package late Wednesday, the latest in a raft of national programs, and the European Union has proposed a 750 billion-euro joint recovery fund that leaders will discuss later this month.
It also shows Lagarde is determined to act preemptively—only about a third of the pandemic program had been spent before Thursday’s increase—to keep markets calm, building on the strategy of her predecessor Mario Draghi. She got off to a shaky start in the pandemic when she inadvertently suggested she might not step in to calm bond volatility in stressed economies such as Italy.
“This is a bit of an economics-policy fireworks—last night the German government with an enormous fiscal stimulus package, and now the ECB,” Carsten Brzeski, chief euro-region economist at ING, told Bloomberg Television. “This is huge.”
The ECB’s purchases should keep a lid on borrowing costs for governments for some time. The central bank said buying will be conducted in a “flexible manner over time, across asset classes and among jurisdictions.” The proceeds from maturing bonds will be reinvested at least until the end of 2022.
“The large expansion of the Pandemic Emergency Purchase Programme creates a huge reserve of fire power to stimulate the economy and prevent any countries in the euro area from being engulfed by a sovereign debt crisis,” said Bloomberg economists David Powell and Maeva Cousin.
The central bank had already sweetened the terms of its liquidity operations in April so that lenders keep extending credit to companies, many of which have seen their revenues eroded by the shutdowns to limit the spread of the virus. Policy makers have refrained from cutting interest rates further below zero amid opposition to negative rates from banks and some politicians.
Lagarde said policy makers didn’t discuss whether to include junk-rated debt in its asset purchases, aside from the exceptions currently being granted to Greek government bonds. She said the decision to act was unanimous, but the exact parameters ultimately decided were the result of a “broad consensus.”
She pushed back against concerns that scope for action could be limited after a German court ruling last month questioned the legality of an older, still-active bond-buying program, saying she’s “confident that a good solution will be found.”