Isabel Schnabel: The European Central Bank's response to the
COVID-19 pandemic
Remarks by Ms Isabel Schnabel, Member of the Executive Board of the European Central Bank,
at a 24-Hour Global Webinar co-organised by the SAFE Policy Center on "The COVID-19 Crisis
and Its Aftermath: Corporate Governance Implications and Policy Challenges", Frankfurt am
Main, 16 April 2020.
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Accopanying slides of the speech.
The COVID-19 pandemic is a shock of unprecedented intensity and severity. The challenges
facing all parts of the economy in dealing with the economic, humanitarian and social
consequences of this crisis are historic.
Central banks are no exception. In my remarks this morning I would like to explain how the ECB
has responded to these challenges, and how our response is contributing to mitigating the
economic and financial fallout from the pandemic, supporting firms and households in the entire
euro area.
I will show tentative evidence that suggests that our measures have helped stabilise broad
funding conditions in the euro area, improve market liquidity and reduce volatility, thereby
safeguarding the financial conditions that are necessary for the achievement of our price stability
mandate.
Addressing risks of adverse macro-financial feedback loops
Euro area financial conditions have tightened significantly in response to the global outbreak of
COVID-19 (slide 1).
Financial conditions indices, which summarise our monetary policy stance by considering price
movements in equity, bond, foreign exchange and money markets, signalled an unprecedentedly
sharp and abrupt degree of tightening in recent weeks.
In a matter of days, the pandemic reversed the previous easing in financial conditions that was
consistent with a return of inflation to our medium-term aim.
This threatened to unleash a perilous macro-financial feedback loop that, if left unaddressed,
would have put at risk the ECB's price stability mandate and endangered financial stability more
broadly.
Swift and determined action was therefore needed to ensure that what had started as an
economic and health crisis would not turn into a full-blown financial crisis, with self-fulfilling and
destabilising price spirals and fire sales.
Our actions were guided by two overarching objectives.
First, to restore the orderly functioning of euro area financial markets, which suffered from an
extraordinary degree of volatility, fast de-risking and thin liquidity conditions.
And, second, to ensure that our accommodative monetary policy continued to be transmitted to
all parts of the single currency area, thereby supporting firms and households in shouldering the
substantial economic and social costs that this crisis would imply.
In achieving these objectives, and in calibrating our response, we had one invaluable asset: our
large and tested toolkit. This meant that, compared to previous crises, the starting point of our
discussion was a widely shared sense of the benefits and costs of the various instruments that
we had employed in the recent past.
For example, a further cut in our main policy rate - the deposit facility rate - would have been
unlikely to support sentiment and market functioning at a time when banks' profitability was
already expected to come under additional pressure due to the crisis.
Previously tested instruments also meant that our decisions could be put in place much more
swiftly, accelerating our response time. And because the experience with unconventional policy
measures was shared widely in the global central banking community, the global monetary policy
response was much more synchronized than on earlier occasions, reinforcing the confidence
effect in financial markets.
The anatomy of our response consists of a carefully calibrated set of three mutually reinforcing
and complementary components.
The first component relates to broad-based asset purchases to address illiquidity and heightened
volatility in core segments of euro area financial markets that threatened to impair the smooth
transmission of our monetary policy.
The temporary pandemic emergency purchase programme (PEPP) constitutes the core of this
component. It foresees purchases at a volume of €750 billion of eligible private and public
securities throughout this year, and longer if needed.
The second component consists of measures that ensure that banks remain reliable carriers of
our monetary policy and continue lending to the real economy.
Our enhanced targeted longer-term refinancing operations (TLTROs), as well as a
comprehensive set of collateral easing measures, form part of this component.
And the third component relates to our traditional role as a lender of last resort to solvent banks.
As part of this component, we offer banks liquidity over longer horizons at the rate of our deposit
facility - that is, at a negative rate - without any conditions attached.
Safeguarding the monetary policy stance
Let me start with the first component, our asset purchases, and explain how our measures have
contributed to improving liquidity conditions and pricing behaviour in euro area sovereign bond
markets, which are central to policy transmission as they form the basis for pricing other assets
in the economy.
Given the importance of sovereign yields in financial markets, a simple measure of our effective
monetary policy stance is the GDP-weighted euro area government bond yield curve (slide 2, left
chart).
In the wake of the Corona outbreak, this curve dislocated perceptibly, leading to an effective
tightening of the monetary policy stance.
We observed a measurable upward movement at all tenors as well as a steepening of the curve.
As a result, just before the announcement of the PEPP on 18 March, GDP-weighted 10-year
euro area sovereign bond yields were around 70 basis points higher than before the outbreak of
the pandemic. Even German Bund yields had risen by around 20 basis points over that same
period.
The announcement of the PEPP helped break this dynamic and partly reversed the steepening of
the curve.
It also reduced the fragmentation that had become increasingly visible as the pandemic spread
at a different pace and intensity through the single currency area (slide 2, right chart).
Everywhere in the euro area, spreads relative to German Bunds fell measurably upon the PEPP
announcement.
Persistent heterogeneity in the euro area has been a long-standing concern for our single
monetary policy. It severely complicates the conduct of our policy. The current crisis exposed
these vulnerabilities, once more, with vigour.
The PEPP was deliberately designed with a view to ensuring that the purely exogenous shock
caused by the coronavirus would not exacerbate and deepen this heterogeneity through
macrofinancial channels, beyond the already wide-ranging economic and social repercussions that this
crisis brings about.
Within PEPP, purchases can therefore be allocated flexibly across time, asset classes and
jurisdictions. This is also why the Governing Council decided to make bonds issued by all euro
area sovereigns, including those issued by the Hellenic Republic, eligible for purchases under the
PEPP.
Nevertheless, financial conditions today remain tighter than they were in mid-February, even for
sovereigns with higher credit ratings, such as the Netherlands or France.
There are two broad reasons for why this might be the case.
The first relates to the fiscal and economic implications of the crisis. The lockdown has caused a
substantial increase in the issuance needs of sovereigns, putting upward pressure on sovereign
yields (slide 3, left chart).
In total, based on available information, Eurosystem staff estimate that the gross issuance of
bonds - excluding bills - by the central governments of Germany, France, Italy, Spain and the
Netherlands will be well in excess of one trillion euro this year alone. These figures will likely
increase further in the coming weeks and months.
Such significant and concentrated issuance naturally implies that investors require a higher
premium for absorbing the additional duration risk on their balance sheets.
This is where our purchase programmes, and the PEPP in particular, kick in.
By absorbing a substantial fraction of the additional duration risk on our balance sheet, our
measures have an important stabilising impact on the euro area sovereign yield curve.
Evidence from term structure models corroborates this view (slide 3, right chart).
In Germany, for example, we had seen a sudden and sharp turnaround in term premia (the red
bars in the chart), and hence in yields, in the run-up to the PEPP announcement, reflecting
expectations of a strong surge in issuance. The PEPP interrupted and reversed this dynamic,
thereby safeguarding the financial conditions that are consistent with our primary mandate.
But because of the wide uncertainty around the ultimate economic and fiscal effects of this
crisis, and the likely substantial additional issuance needed in coming years, yields have not fully
reversed and remain above pre-Corona levels.
These effects are likely to have been aggravated by the second factor - the challenging market
liquidity.
Although the announcement of the PEPP triggered an improvement from previously impaired
levels, liquidity is still far from normal. Bid-ask spreads, even in deep liquid markets, such in the
German Bund market, remain well above the norm (slide 4, left chart).
Eurosystem portfolio managers often report a limited amount of offers and sometimes no
sufficient quotes for bonds, in particular for those issued by some smaller jurisdictions.
To improve liquidity further and reduce volatility, we decided to use the full joint flexibility of our
asset purchase programmes, both the APP and the PEPP, and increased our presence in the
market by frontloading purchases measurably (slide 4, right chart).
Current weekly purchase volumes far exceed the levels we have implemented over the lifetime of
the APP so far, even compared to the period when purchases were running at a monthly pace of
€80 billion in 2016.
And the Eurosystem has been using all the inbuilt flexibility of the programmes, not only over
time, but also across jurisdictions and market segments.
As uncertainty over the depth of the shock will start to fade, our purchases will contribute to
crowding in other private and public investors, thereby reducing liquidity premia and restoring
orderly trading conditions. In this way, our measures offer an important bridge into hopefully
better times.
Measures in support of firms and banks
Similar considerations guided our decisions for mitigating the impact of the crisis on the funding
conditions of firms and banks, over and above the effects on the sovereign yield curve.
From the very beginning of this crisis, we were conscious that extraordinary liquidity support was
needed in segments of the financial and capital market that were directly exposed to the fallout
from the Corona pandemic.
For this reason, we decided to redirect a considerable fraction of the additional €120 billion
purchase envelope under the APP, as well as of the PEPP, for eligible private sector bonds.
These private sector purchases, which also include commercial paper, directly contribute to
1
credit easing for non-financial corporates.
But since the euro area is traditionally a bank-based economy, measures supporting the liquidity
in financial markets were unlikely to prove sufficient. They needed to be accompanied by
measures that ensured that financing conditions for small and medium-sized firms would remain
equally attractive.
These considerations form the core of the second and third component of our response:
preserving viable bank lending conditions and acting as a lender of last resort to solvent banks.
Together with the first component they provide a reliable backstop for firms and households
during these challenging times.
To see this, consider first firms' market-based financing conditions.
Corporate bond spreads had risen sharply before the PEPP announcement (slide 5, left chart).
Increased purchases of corporate bonds under both the APP and the PEPP have visibly
contributed to stabilising credit spreads for both investment grade and high yield issuers and
stimulating bond issuance (slide 5, left and right chart).
The strong revival of the primary market for corporate bond issuance has been an important pillar
for supporting liquidity buffers of cash-strapped firms, also in view of the evidence that firms have
started to heavily draw down bank credit lines, which is weighing on bank capital.
Yet, as in the sovereign space, market-based financing conditions for firms remain significantly
tighter compared with the conditions that prevailed over the past few years, reflecting the
massive impact of this crisis and the large remaining uncertainty.
Our measures in support of bank lending, together with the loan guarantee schemes provided by
governments, attempt to mitigate this friction.
In particular, for counterparties maintaining their levels of credit provision to the real economy
over a defined horizon covering the outbreak of the pandemic, the rate applied in our targeted
longer-term refinancing operations (TLTRO-III) can be as low as 25 basis points below the
average interest rate on the deposit facility, which currently implies a rate of -75 basis points.
By providing strong monetary incentives for banks to maintain their lending to the real economy
under our TLTRO-III, we contribute to more favourable bank lending conditions, which tend to
exhibit a much larger degree of inertia than market-based funding costs.
In Italy, for example, bank lending conditions for firms remained remarkably resilient in recent
years despite significant swings in market-based funding conditions of the sovereign, banks and
firms. Again, our measures can provide a valuable bridge to the future and help keep aggregate
external funding costs of firms stable until the economy recovers and uncertainty diminishes
further.
Two other features of our package reinforce the bank lending channel.
These are, first, our plain-vanilla longer-term refinancing operations (LTROs), which provide
abundant liquidity to banks at favourable rates at a time when term funding has become scarce
and more expensive.
The second feature relates to the easing in collateral standards for lending operations. We now
accept a much broader set of assets as collateral, including loans of small size to small and
medium-sized enterprises (SMEs) or even self-employed workers, and we accept them at more
favourable conditions.
This increases the liquidity of the asset side of banks' balance sheets, and thereby provides
further incentives to extend credit to the real economy, even during the current challenging
period.
Macroeconomic implications of the pandemic
Taken together, and in conjunction with the actions taken at European and national level, our
measures provide tangible support to the euro area economy at a time when uncertainty looms
large and downside risks to the medium-term inflation outlook have increased.
ECB staff is currently assessing the extent to which the current crisis will affect the likely future
inflation and growth trajectories.
In the short run, headline inflation can be expected to drop measurably on the back of the decline
in energy prices. The March HICP release was a harbinger of what can be expected in coming
months.
In the medium run, the effects on inflation, and underlying inflation in particular, will likely depend
on two broad factors: first, the depth and persistence of the shock, including possibly protracted
hysteresis effects in labour, financial and product markets; and, second, on the effectiveness of
the economic policy measures taken in response to the crisis.
Although it is too early to assess the full impact of these measures, there is tentative evidence
that the fast and resolute policy actions by authorities worldwide, and by central banks in
particular, have already contributed to restoring cautious confidence among professional
forecasters.
For example, the latest private sector forecasts collected by Consensus Economics still point
towards expectations of a V-shaped recovery for the euro area, with a sharp mean decline in
GDP of 5.7% this year and a rebound of almost similar magnitude in 2021 (slide 6, left chart).
As a result, while inflation expectations for this year have dropped sharply, the revisions to
inflation expectations for the coming years have been limited, and private sector forecasters
continue to see inflation in the euro area converging to levels closer to 2% over the next three to
four years (slide 6, right chart).
But two points are worth noting.
First, uncertainty around these estimates is considerable, with forecasts for next year's inflation
ranging from -0.4% to 2.5%. Any mid-point forecast therefore needs to be taken with a grain of
salt.
Second, private sector forecasts appear considerably more optimistic than the latest projections
by the IMF, which sees euro area GDP contracting by 7.5% this year and predicts a markedly
weaker rebound of only 4.7% in 2021.
Conclusion
Let me conclude.
What shape the recovery will ultimately take remains highly uncertain at the current juncture,
even as authorities gradually start to ease lockdown measures in some economies.
The ECB has responded forcefully to this historic crisis by adopting a wide-ranging set of
carefully calibrated measures that collectively help mitigate the economic and financial fallout
from the pandemic. Our measures contribute to easing financing conditions of firms and
households and supporting banks in their effort to maintain viable liquidity conditions in the
economy at large.
The Governing Council will continue to monitor closely the implications of the pandemic for the
economy, and stands ready to adjust all of its instruments, as appropriate, to ensure that inflation
moves towards its aim in a sustained manner and to avoid fragmentation that may hamper the
smooth transmission of our monetary policy.
At the same time, other authorities will have to play their role as well, since ultimately the
recovery will depend on the right combination of monetary policy and effective fiscal and
regulatory policy, both at national and at European level.
Thank you very much for your attention.