ECB to shield weakest euro economies from rating cuts

Bloomberg

The European Central Bank (ECB) will accept some junk-rated debt as collateral for its loans to banks in a move that aims to shield the euro area’s most vulnerable economies as they face the risk of credit downgrades in the coronavirus.
The ECB will accept bonds as long as they had at least the lowest investment grade on April 7, it said after policy makers held a call. The decision to ignore future cuts comes two days before a possible reduction for Italy by S&P Global Ratings. Yields on 2-year Italian debt were down 11 basis points on Thursday at 1%.
The prospect that some government and corporate bonds may face downgrades because of the cost of fighting the pandemic has unsettled investors. It threatens to limit the ability of distressed companies to access the credit they need to survive.
Those concerns have been exacerbated by the failure of European Union governments so far to agree on joint measures to combat the biggest recession in living memory. EU leaders are due to hold a call on Thursday.
Fresh signs of economic damage from lockdown measures to contain the virus are emerging daily. Figures Thursday showed huge plunges in business and consumer confidence in France and Germany, the euro area’s two largest economies.
The ECB, meanwhile, has spent recent weeks helping to offer credit to companies and ramping up bond-buying programs to calm markets. Its latest measures will apply until September 2021, and “appropriate” discounts on the funds banks can access — known as haircuts — will apply. Bonds will be eligible as long as their new ratings remain at or above the BB level.
“The ECB move seeks to ensure that rating downgrades do not lead to a collateral crunch that would impair bank lending,” Krishna Guha, head of central bank strategy at Evercore ISI, said in a note. “It involves the ECB, quite appropriately in our view, being willing to take still more credit risk onto its balance sheet.”
The ECB’s statement referred only to collateral, without saying whether junk-rated debt would be also be accepted for its asset-purchase programs. Those are the biggest part of its monetary stimulus, as it plans to spend more than 1 trillion euros ($1.1 trillion) on bond purchases this year.
Still, the central bank signalled that step may lie ahead. It said it may “take additional measures to further mitigate the impact of rating downgrades, particularly with a view to ensuring the smooth transmission of its monetary policy in all
jurisdictions of the euro area.”
“When push comes to shove, the European Central Bank has always done what’s needed to prevent the euro area from being torn apart — at least eventually. Similarly, it’s unlikely to allow rising yields to tip Italy into a sovereign debt crisis,” said David Powell.
S&P Global Ratings is set to review Italy’s credit rating on Friday, which it currently ranks two notches above investment grade with a negative outlook. Moody’s is due to review Italy in May.
The premium investors demand to hold 10-year Italian debt over Germany’s has widened in recent days — a sign of concern — despite the country managing a successful bond sale on Tuesday. In raising more than 110 billion euros, it reminded investors just how much it needs the cash. The spread narrowed Wednesday before the ECB decision.
The US Federal Reserve has said it’ll buy high-yield debt and exchange-traded funds as part of a program to support small and mid-sized businesses during the crisis, and the ECB has already set its own precedent for purchasing junk.
It agreed last month to allow Greek government bonds, which are rated well below investment grade, as part of its emergency bond-buying program in an acknowledgment of the broad scope of the coronavirus shock.
The latest measures “aim to ensure that banks have sufficient assets” that they can use to “continue providing funding to the euro area economy,” the ECB said in its statement.