ECB bond buying is a matter of time as debt balloons

Bloomberg

It’s increasingly becoming a question of when, not if, the European Central Bank (ECB) will pump up its emergency bond buying program to help the most vulnerable euro-area economies avoid a deeper recession.
With countries relying on borrowing to finance their response to the coronavirus pandemic, the ECB will likely take on more of that bond supply, as private investors steer away from taking on risk. The crisis will spur governments to issue an extra 850 billion euros ($935 billion) this year, according to analysts at ABN Amro.
The central bank isn’t expected to buy all the additional debt, but its role needs to be big enough to keep borrowing costs low and ensure that the economic shock doesn’t turn into a debt crisis like the one that nearly tore the monetary union apart less than a decade ago.
The 750 billion-euro pandemic bond-buying program has emerged as the ECB’s preferred tool in fighting Europe’s worst post-war economic crisis. Economists surveyed by Bloomberg before this week’s policy meeting expected central bankers to add 500 billion euros later this year.
The Governing Council on Thursday kept the size of the program unchanged, opting instead to use other tools to boost bank lending. But President Christine Lagarde said it can increase and be extended beyond 2020.
While private investors are likely to line up for the safest debt, such as Germany’s, they may demand increasingly higher interest rates from weaker nations such as Italy and Spain — which are also the hardest hit by the virus.
That so-called risk premium would flow through to other interest rates for business and consumer loans, deepening the recession. In the worst case, it could make government repayments unaffordable.
While the ECB’s primary role is to ensure price stability, it considers safeguarding monetary stability complementary to that.
It allows the central bank to skew bond purchases toward heavily indebted Italy. Bond yields there have subsided since the program started in March in a sign that the ECB is doing just that, and a bond sale passed successfully last month. Still, the nation’s credit rating was unexpectedly downgraded by Fitch.
Lagarde called the PEPP the “best tool that we have in our toolbox.” Chief Economist Philip Lane, who writes the policy proposals for the Governing Council, echoed that sentiment the next day.
The ECB’s worst-case scenario sees the economy shrinking as much as 12% this year and not returning to its pre-virus size until the end of 2022. That suggests a long and
expensive recovery.

“The economic shock and related funding needs are likely going to be much larger than what the ECB anticipated,” economists at Bank of America, who predict the bond plan will be expanded to 1.5 trillion euros and extended into 2021, wrote in a note. “The European government response remains lacking and inappropriate.”