ECB boosts bond-buying stimulus package by €600bn

The European Central Bank has added an extra €600bn to the bond-buying programme that it launched to support the eurozone’s pandemic-stricken economy as it steps up its efforts to stop the region sliding into a deflationary spiral.

ECB president Christine Lagarde said the eurozone economy was “experiencing an unprecedented contraction”, adding that “severe job and income losses and exceptional uncertainty” had led to a “severe fall” in both consumer spending and investment. 

The move to increase the ECB’s pandemic emergency purchase programme to a new total of €1.35tn was slightly larger than most economists’ expectations and means the central bank is on track to buy a record total of more than €1.7tn of assets this year.

The PEPP had been on course to run out of firepower by October, having already spent more than €234bn of its original €750bn total by late May.

The ECB also extended the timeframe of its emergency bond-buying scheme until June 2021 and said it would “continue net asset purchases under the PEPP until it judges that the coronavirus crisis phase is over”.

There had been a “bottoming out” in economic activity in May but the recovery had so far been “tepid” compared with the speed with which the economy had contracted after the pandemic hit, Ms Lagarde said. She added that inflation had been dragged down by lower energy prices but would “remain subdued” because of the sharp decline in economic activity.

Line chart showing the Eurozone inflation rate from 1999 to 2020. Recent months have seen the rate fall towards zero, away from the ECB target of near 2 per cent.

The ECB published new forecasts, predicting the eurozone economy would shrink 8.7 per cent this year before expanding by 5.2 per cent next year and 3.3 per cent in 2022. 

It also slashed its inflation forecasts to 0.3 per cent this year, 0.8 per cent next year and 1.3 per cent in 2022 — all well below its core target for price growth to be below but close to 2 per cent. 

Announcing the decision on Thursday, the central bank said: “In response to the pandemic-related downward revision to inflation over the projection horizon, the PEPP expansion will further ease the general monetary policy stance, supporting funding conditions in the real economy, especially for businesses and households.”

Keeping its main deposit rate unchanged at minus 0.5 per cent, the ECB said: “The maturing principal payments from securities purchased under the PEPP will be reinvested until at least the end of 2022.”

It added: “In any case, the future roll-off of the PEPP portfolio will be managed to avoid interference with the appropriate monetary stance.”

Some investors had worried that the ECB’s initial bond-buying plan would not have been sufficient to soak up the extra debt of between €1tn and €1.5tn that eurozone governments are expected to issue this year, leaving some of the worst-hit countries, such as Italy, facing a surge in their borrowing costs.

Yields on Italian and Greek government debt dropped sharply after the announcement; yields fall when prices rise. The yield on 10-year Italian debt dropped 16 basis points to 1.41 per cent and on equivalent-maturity Greek debt fell 13bp to 1.40 per cent, the lowest level since early March. The difference between yields on 10-year German and Italian bonds — a widely watched indicator of eurozone political risk — declined to 1.76 percentage points, its narrowest since late March.

Line chart of Spread between 10-year German and Italian bond yields (percentage points) showing Eurozone bonds rally after ECB stimulus announcement

The move shows Ms Lagarde wants to stay ahead of the curve, some analysts said, after she was forced to apologise to colleagues in March for giving the impression that she was reluctant to act to combat a sell-off in the bonds of southern European countries.

“To judge by the size of today’s uplift, it appears that [Ms] Lagarde has well and truly learned her lesson from early March’s mis-step,” said Kenneth Wattret, chief European economist at IHS Markit. “The ECB has bought itself some time but the pressure will inevitably build to do more.”

Strategists at ABN Amro argued that “a further increase in the PEPP envelope will likely follow later this year”.

“This reflects the deep recession in the economy and the significant disinflation it will trigger over the coming years,” they said.

Coming only weeks after Germany’s high court ruled that the ECB’s older sovereign bond-buying scheme had breached the country’s constitution, the central bank’s latest move showed it was determined not to let the ruling hamper its freedom to act.

Additional reporting by Philip Stafford in London