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ECB Hints at Geographic Targeting of PEPP Purchases

The European Central Bank (ECB) will continue to bend its rules on the geographic allocation of emergency sovereign bond purchases, deviating from its capital key to support nations in financial distress.

“We raise the share of purchases above the capital key in countries facing severe risks of fragmentation,” said ECB governing council member Isabel Schnabel, addressing an online seminar hosted by the Florence School of Banking and Finance.

The ECB has faced questions over the allocation of its Pandemic Emergency Purchase Programme, or PEPP, with northern eurozone members opposed to heavy purchases of bonds issued by more fiscally challenged southern nations, such as Italy and Greece. Purchases under the ECB’s previous quantitative easing programmes have been allocated in accordance with the size of member states’ economies.

But the “flexibility” of the PEPP programme, across a range of financial assets, including commercial paper, has reduced interest rates across the bloc, said Schnable.

“ECB staff estimates show that the dispersion of the impact of PEPP on yields across the euro area countries was indeed substantial,” citing evidence that €500 billion in PEPP purchases packed twice the power as the same-sized investment under the Bank’s existing asset purchase programme.

ECB rate setters have publicly voiced concern over eurozone yield spreads after President Christine Lagarde told reporters in March that the central bank is “not here to close spreads”.  Lagarde’s comments spurred a sharp selloff in Italian government bonds, eliciting a clarification from the then-new ECB leader.

Analysts believe the €1.35 trillion PEPP programme – due to run for at least another 12 months – could be exhausted by February, suggest further increases in months to come, particularly with the ECB lukewarm about the eurozone’s prospects for recovery. Under the ECB’s baseline scenario, growth will contract by 8.7% in 2020, and even a less-severe recession will not return the eurozone economy to its previous growth trajectory by the end of 2020, said Schnabel.

The governing council member also stressed the pandemic could leave permanent scars on the eurozone economy. Many industry sectors will fail to return to their previous size, and unfinished structural reforms in many eurozone nations could prevent the necessary “reallocation of capital and labour” to maximise growth, she said, adding that small business failures “could amplify trends in economic concentration that we have already observed prior to the crisis, particularly in the United States”.

Laurie Laird

Julie Ros

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