ECB: Extending Accommodation

Published on December 3, 2020
SGH Insight
*** ECB sources indicate the consensus next week appears to lie in expanding the 1.35 trillion euro PEPP (Pandemic Emergency Purchase Program) by 500 billion euros and to extend its term from June 2021 to “at least” through the end of 2021, although there is an outside chance they might choose to double that commitment to a full-year extension. ***

*** We believe the ECB will also revamp and extend the -1.0% bonus TLTRO-III (Targeted Longer-term Refinancing Operations) lending rate, a subsidy, in effect, offered to banks that meet certain lending criteria beyond its current June 2021 expiration. They could lower that subsidy rate even more, but we would put that on balance at perhaps even odds, and there will be consideration of a new round of five-year TLTRO loans to expand on the current three-year TLTRO-III program. ***

*** We continue to expect the ECB to hold pat on its -0.5% benchmark deposit rate. But a rate cut will probably be discussed at this meeting and wielded as an option in the Governing Council tool kit if needed, especially to try and counter the relentless strength in the euro. ***
Market Validation
(CNBC 12/10/20)

ECB expands and extends its bond buying as coronavirus resurgence weighs on the recovery

The European Central Bank on Thursday expanded its massive monetary stimulus program by another 500 billion euros ($605 billion), as a second wave of lockdown measures weigh on the euro area’s economic recovery.

Markets had largely expected the central bank to add to its bond buying, having vowed back in October to “recalibrate its instruments” as a resurgence in coronavirus cases across the continent led to further national shutdowns.

The ECB held interest rates on its main refinancing operations, marginal lending facility and deposit facility at 0.00%, 0.25% and -0.50%, respectively.
The central bank launched its Pandemic Emergency Purchase Programme (PEPP) in a bid to shore up the bloc’s economy in the wake of the pandemic. Following Thursday’s expansion, the total asset purchase value is 1.85 trillion euros, and the ECB extended the horizon for purchases under the PEPP to March 2022.

In a statement following the decision, the ECB said it would conduct net purchases until its Governing Council judges that the “coronavirus crisis phase is over,” and restated that interest rates would remain at their current low levels until it the central bank sees the inflation outlook “robustly converge” to its target of “close to, but below” 2%.

The Governing Council also opted to “recalibrate” the third edition of its targeted longer-term refinancing operations (TLTRO III), which are ultra cheap loans for banks, by extending the current favorable terms to lenders by 12 months until June 2022.

European Central Bank officials, led by President Christine Lagarde, have signaled in no uncertain terms that they will be looking to add to the eurozone’s already massive monetary stimulus at their final meeting of the year, leaving markets only to guess at the exact measures that will be rolled out on December 10.

*** ECB sources indicate the consensus next week appears to lie in expanding the 1.35 trillion euro PEPP (Pandemic Emergency Purchase Program) by 500 billion euros and to extend its term from June 2021 to “at least” through the end of 2021, although there is an outside chance they might choose to double that commitment to a full-year extension. ***

*** We believe the ECB will also revamp and extend the -1.0% bonus TLTRO-III (Targeted Longer-term Refinancing Operations) lending rate, a subsidy, in effect, offered to banks that meet certain lending criteria beyond its current June 2021 expiration. They could lower that subsidy rate even more, but we would put that on balance at perhaps even odds, and there will be consideration of a new round of five-year TLTRO loans to expand on the current three-year TLTRO-III program. ***

*** While the enormous volume of purchases will be cutting into supply, even with added sovereign issuance, the ECB will not raise its self-imposed, and politically important, 33% collective action clause limit on bond ownership. The ECB we believe will instead look to expand both the universe of securities it can purchase and that it will accept as collateral for TLTRO loans, but we suspect that with a wary eye on potentially mounting credit risks, these changes, if they come now, will be on the margins. ***

*** We continue to expect the ECB to hold pat on its -0.5% benchmark deposit rate. But a rate cut will probably be discussed at this meeting and wielded as an option in the Governing Council tool kit if needed, especially to try and counter the relentless strength in the euro. ***

Getting through a Challenging 2021

Investors would be well-served to keep two of the ECB’s overarching objectives in mind in handicapping the contours of this next round of stimulus.

The first is that the intention of the Governing Council is not necessarily to drive the already extremely accommodative monetary conditions even lower, but mostly to extend them in time.

The second is that the ECB must balance a desire for extending stimulus into targeted sectors of the economy with its concerns over driving a fragile banking system in the process too aggressively down a corporate credit chain that is expected to deteriorate next year without the appropriate amelioration measures.

On the extension of accommodative conditions, when the ECB decided to increase the PEPP (Pandemic Emergency Purchase Program) on June 4 of this year from 750 billion euros to 1.35 trillion euros, and to extend the program through “at least” June 2021, that was predicated on expectations of a recovery setting in by H1 of 2021.

But with continued and frustrating misses still on the inflation front, and as it became increasingly clear that H1 2021 will also be a tough slog, the ECB turned its focus to extending that accommodation at least through H2 of 2021 in order to ensure no tightening of financial conditions even if the recovery has set in by then. Of course, a commitment to more easing later also translates into easier conditions now.

The Bond Purchase Programs

In concrete terms, sources indicate that expectations for an around 500 billion euro add and six-month extension through the end of 2021 to the 1.35 trillion PEPP “envelope” are pretty much on the mark, even though with only about half of the program used, that would leave plenty of headroom to buy more bonds beyond June anyway, especially as purchases are expected to slow down around the holidays as markets thin out.

There is essentially no chance that the ECB will deliver less than that on the PEPP, and a non-negligible albeit we think outside chance they will go out more aggressively for a full year extension with a higher number.

Diving deeper into the details, our understanding is that between the PEPP and the pre-pandemic Asset Purchase Program (APP), the ECB and National Central Banks are hoovering up even more bonds than their sovereigns can issue, and so supply is shrinking, and scarcity becomes an issue.

The ECB will therefore need at some point, perhaps this meeting, to look to expand the universe of securities it can purchase. However, there appears to be a little hesitation in expanding that to the outright purchase of “fallen angel” corporate credits that are already accepted as collateral for TLTRO loans (Targeted Long-term Refinancing Operations). Equity purchases remain a non-starter, as is any tinkering with the self-imposed 33% ownership limit rules.

Loans, Banks and the Real Economy

It is no mystery that the ECB will be also looking to revamp and adjust its TLTRO-III bank lending program. In particular, the ECB will focus on the generous provision that allows banks to borrow at a “bonus” rate of as low as -1.0%, in other words a subsidy rate, if they meet certain lending requirements to the real economy.

While the existing TLTRO program has multiple tranches that are yet to be tapped, that extra benefit to the banks, and added incentive to lend, runs out in June of 2021 and will be extended. But when it comes to aggressively loosening the criteria by which banks qualify for the -1.0% rate, it becomes a little tricky.

Sources point to the need to balance a desire to push more lending into the system, and support banks in the process, with concerns over inadvertently pushing lending too far into credits that may very well turn sour over the coming year or two.

On the other side of the ledger, while the expansion of bank lending activities that would qualify for subsidy loans to include mortgage lending would in theory encourage massive new lending in one fell swoop, the residential housing sector is seen as already quite strong. ECB officials are also sensitive to the optics of boosting the wealth of owners versus renters through additional mortgage stimulus, as opposed to stimulating sectors like green energy and alternative energy that have a more unqualified positive social impact.

Borrowing and Lending Rates

A cut in the -0.5% benchmark deposit rate we believe will be discussed next week, especially to manage the disinflationary impact of the slow but steady grind higher in the euro, but we continue to believe the deposit rate will not be cut at this meeting (see SGH 10/23/20: “ECB: A Shaky Setup for 2021”). 

While the ECB will stress that there is still room to cut deeper into negative territory, if needed, and that rates are not yet at “reversal rate” levels, the risk reward clearly shifts with banks, who have complained about the penalty rate, already facing a potentially challenging 2021 in loan losses.

The ECB has of course instituted a “tiering system” to ameliorate some of the hit to bank earnings of negative rates, exempting six times qualifying banks’ excess reserves that are held in the euro system from negative rates, and this multiple can be adjusted. But our understanding is that such an adjustment would likely come if or when rates are dropped further and will be kept in the back pocket for now.

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