During the last monetary decision by the European Central Bank on March 12, 2020, investors remained inextricably uncertain about the policy guidance and intervention by the ECB president Christine Lagarde.
The ECB sought to reassure markets through the provision of liquidity lines intended to trickle to European corporates and an additional net asset purchase programme of €120 billion till the end of the year over and above the existent €20 billion a month of asset purchases, while keeping rates on hold.
This intervention was deemed insufficient by markets given the scale of challenges faced by Euro Area economies. During the press conference, the President of the ECB, Lagarde stressed that she hoped that she would not have to use the ‘whatever it takes’ statement previously used by her predecessor Mario Draghi.
Fast-forward by six days and on March 18, the ECB issued a statement saying that the governing council decided to launch a new temporary asset purchase programme of private and public sector debt to counter the serious risks to the monetary policy transmission and the outlook for the euro area posed by the outbreak of COVID-19.
As assurance to the financial system, the statement read: “The Governing Council will do everything necessary within its mandate”. The pandemic emergency purchase programme will have an overall budget of €750 billion in asset purchases till the end of 2020. Effectively, measures taken to curb the spread of COVID-19 require the total closure of businesses and therefore economies. The spread rate from Italy to other regions in Italy, and countries became alarming by the day. This led to heightened uncertainty as Italy was one of the first countries to provide a fiscal package growing from €8 billion to €12 billion and then settled at €26 billion.
This government expenditure coupled with the fragility of the Italian economy meant that the indebted nation will continue to load on more debt. In basic terms, the economic principle is that a nation which takes on more debt, becomes riskier and therefore the credit spread (i.e. the interest to be charged over and above less risky debt of other nations) will have to increase. This would mean a greater interest burden for the ailing nation that risks capitulation.
The ECB foresaw that credit spreads will widen in times of turmoil given the weak economic fundamentals of peripheral nations and therefore stepped in with a significant asset purchase programmes to calm credit markets. Indeed, the 10-Year Italian bond was trading c. 2.39 per cent prior to the announcement which then rallied to 1.39 per cent on market open. The last thing that the ECB wants is a sovereign debt crisis observed in 2012 during this exogenous shock. Indeed, for the pandemic emergency purchase programme, the ECB also announced that it will be buying Greek debt as well.
Despite this bold intervention by the ECB, markets still remained agitated as the coronavirus cases kept increasing. The ultra-accommodative stance by the ECB resulted in the Euro currency to fall against benchmark currencies, most notably against the dollar which at the time of writing is trading at $1.0670 per €1 from the previous three day average of $1.10 per €1.
The intention of the ECB during this period is to maintain the taps open for credit to flow to businesses that need to fund their short term liquidity needs by anchoring interest rates to a bare minimum. On the other hand, governments need to do their part by cushioning the blow for businesses in order to ensure economic stability in these times of financial distress.
Disclaimer: This article was issued by Jesmar Halliday, CFA. investment manager at Calamatta Cuschieri. For more information visit www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.