ECB’s unity claims are woefully misleading

Earlier in March, the European Central Bank (ECB) announced that it would buy more bonds to stop borrowing costs rising. It was worried that the euro zone economy was in such poor shape that it couldn’t afford to have European bond yields dragged higher by their US cousins.
On March 22, to mark the one-year anniversary of its Pandemic Emergency Purchase Programme (PEPP) — which has expanded to 1.85 trillion euros ($2.2 trillion) — a blog attributed to ECB President Christine Lagarde said the central bank would “significantly” increase bond purchases to stop unwarranted tightening in financial conditions. Lagarde said there was total consensus on the governing council for this move.
As with many ECB claims, this is both trivially true and woefully misleading. There is, in fact, growing pressure within the ECB for it to scale back its bond purchases. European bond yields are likely to rise, therefore, and sooner and faster than the ECB would like.
Lagarde’s comments were trivially true because it is indeed the case that the ECB’s governing council thought it ought to do something or, perhaps more accurately, needed to be seen to be doing something. Even the more hawkish members, the bloc’s northern creditor countries, agreed with this. Whether this is because of rising yields or because of Europe’s cack-handed political management of the pandemic is a moot point. But this is where agreement stopped. There is no accord among the ECB’s council members as to how many more bonds the ECB will buy, nor for how long it will keep buying. Creditor countries are increasingly fed up of bailing out their more profligate neighbours via insanely low interest rates — the euro zone’s deposit rate is minus 0.5%, two-year German bond yields minus 0.7% and German 10-year yields minus 0.28% — and a European payments system that rejoices in the name of Target2.
Germany is the poster child for the damage caused by negative rates. It has a rapidly ageing population which, to be blunt, can’t afford to retire. That is why, as Andrew Hunt, an independent economist, points out, lower interest rates lead to higher savings. All things equal, more savings means less spending and investment and lower growth. Absent a pickup in growth led by external demand there is thus a positive correlation between the country’s growth and the level of real rates: As rates go down, so does growth and vice versa.
The damage inflicted on Germany’s savings has been savage. The proportion of negative-yielding assets on German banks’ balance sheets has been rising remorselessly. Hunt estimates that, at worst, more than a third of their assets yield less than nothing. Households have been forced to take more risk to generate returns. Alas, their endeavours have been less than successful. Hunt calculates that since 2005 overseas investments have lost the country’s investors more than 1 trillion euros.
Although German savers and financial institutions are desperate for higher returns, the ECB has been more concerned with gluing the euro area together, by keeping debtor countries’ borrowing costs as low as possible. This is where Target2, which is used by central banks and commercial banks in the EU to process cross-border euro payments, comes in.
Target2 is described by the ECB as merely a settlement system. This isn’t true. In normal settlement, both positions are cleared; there’s no residual exposure on either side. That’s not true of Target2, which is why exposures to it keep rising. In contrast, Fedwire, the US bank settlement system, settles every day. In fact, Target2 is in effect a way of forcing creditor countries in the euro zone to lend at non-economic rates to debtor countries via their central banks.

—Bloomberg