Oliver Mangan: ECB has the firepower and political backing to prevent post-Covid debt crisis

Eurozone leaders met again last week for discussions on designing a recovery plan to tackle the enormous Covid-19 economic crisis and the European Commission has now been tasked with the job.
Oliver Mangan: ECB has the firepower and political backing to prevent post-Covid debt crisis
Christine Lagarde

Eurozone leaders met again last week for discussions on designing a recovery plan to tackle the enormous Covid-19 economic crisis and the European Commission has now been tasked with the job.

However, major differences remain between member states on the size of the proposed rescue fund and whether the monies should be channelled through loans or grants.

Eurozone countries are also still badly divided on debt mutualisation which involves issuing eurobonds or so-called corona bonds.

In these circumstances, the ECB remains the only show in town in preventing the deep economic crisis morphing into an enormous debt crisis in the eurozone.

The good news is that the ECB led by Christine Lagarde has the appetite, the firepower and it seems the political backing to prevent a debt crisis occurring.

Ironically, while some EU countries and their governments have great difficulty in digesting mutualised bond issuance, they have much less difficulty with the ECB buying member states’ sovereign bonds, in enormous quantities.

The alternative to the ECB’s bond-buying programme would be a debt crisis that risks a break-up of the EU and the single currency. This is the last thing the stronger member states of the EU would want.

The ECB’s new €750bn Pandemic Emergency Purchase Programme, or PEPP, has meet with limited success in lowering eurozone bond yields since it was launched in mid-March.

Italian bond yields initially fell back very sharply, but have drifted higher this month, as have Spanish bond yields.

In launching the €750bn package, the ECB indicated it was fully prepared to increase the size of its bond purchases and adjust their composition. And we could see the package expanded, possibly as early as the ECB meeting on Thursday.

Essentially, the ECB is the real national central bank for every eurozone member state and could become the lender of last resort to their governments in the same way as the Federal Reserve in the US and the Bank of England in the UK.

A big shift in ECB policy, should yields levels rise sharply in peripheral countries, would be to become active in the primary market and buy bonds at issuance from governments rather than just through the secondary market as happens presently.

Meanwhile, a rise in interbank borrowing costs in the peripheries may be a factor in pushing three-month Euribor to a four-year high in recent days, a development that is likely to be of concern the ECB.

Even the potential for an official rate cut could be revisited in light of the upward pressure on interbank rates although there has been no hint that any such cut is coming at Thursday’s meeting.

The ECB may instead consider a further easing of liquidity measures—indeed, only last week the ECB announced it will continue to accept bonds that lose their investment-grade status as collateral until September 2021.

- Oliver Mangan is chief economist at AIB

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