Peter Praet: The APP impact on the economy and bond markets
Intervention by Mr Peter Praet, Member of the Executive Board of the European Central
Bank, at the annual dinner of the ECB's Bond Market Contact Group, Frankfurt am Main,
30 June 2015.
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It is a pleasure for me to welcome you to the annual dinner of the Bond Market Contact
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Group (BMCG), also on behalf of my colleagues of the Executive Board.
We regard the BMCG as a forum to improve our dialogue with the financial market
community on bond market-related issues. Understanding bond markets is obviously key for
us, and even more so as bond purchases have become a central part of our non-standard
measures. The broad composition of the group has proved useful for understanding the
implications of our actions and other market developments for all bond market participants. In
remarks today I would like to briefly assess the current economic situation before addressing
a few salient points about the ECB's expanded Asset Purchase Programme (APP).
So far the economic recovery in the euro area remains on track and, importantly, we are
seeing evidence that it is starting to broaden. Real GDP rose by 0.4% q-o-q in the first
quarter of 2015, with domestic demand continuing to be the main driver behind output
growth. While growth has been mainly supported by private consumption in recent quarters,
there are encouraging signs that private investment is picking up as well. The latest survey
results, though showing some signs of stabilisation, remain consistent with continued growth
in the second quarter at around the same rate as in the first quarter.
A number of factors are underpinning the recovery in activity. First, the earlier fall in oil prices
is contributing to higher real disposable incomes and corporate profitability. Second, the
accommodative monetary policy stance, including the expanded APP, has led to
improvements in financial conditions and credit supply conditions. Third, euro area activity is
expected to be increasingly supported by the past depreciation of the euro and the gradual
strengthening of external demand. These three factors mean that, while remaining on the
downside, the risks surrounding the economic outlook have become more balanced.
It is nonetheless clear that monetary policy and external factors cannot alone be the basis for
a lasting recovery. I see two risks in particular to a stronger, structural recovery. The first is
that pessimism among firms about future growth prospects continues to weigh on
investment. 5 years ahead growth expectations among forecasters have been falling
continuously since 2001, from around 2.7% then to 1.4% today, which may have sapped
"animal spirits". The second is the persistence of a debt overhang in parts of the euro area
which acts as a major drag on firm and household spending. In both cases structural reforms
come to the fore, as lifting expectations of trend growth is key to reduce uncertainty about the
outlook and deleverage private sector balance sheets.
This context of a firming recovery underpins our expectation for inflation to steadily return
towards our objective. Since the trough in January, headline inflation for the euro area has
followed a generally upward trajectory as the negative contributions from energy prices have
declined. Though Eurostat's flash estimate for euro area HICP in June came in at 0.2% - 0.1
percentage points lower than for May - this slight decrease largely reflects calendar effects
and does not affect our baseline forecast. We still expect inflation to remain low in the
months ahead before accelerating later this year, in part on account of base effects
associated with the fall in oil prices in late 2014. Thereafter, inflation is expected to gradually
converge towards levels closer to but still below 2%.
That outlook is of course contingent on the full implementation of our APP. As of 26 June
2015 the ECB had purchased EUR 297.1 bn under the entire APP, including EUR 193.9 bn
under the Public Sector Purchase Programme (PSPP), EUR 94.6 bn under the Covered
Bond Purchase Programme (CBPP3) and EUR 8.6 bn under the Asset-Backed Securities
Purchase Programme (ABSPP). Accordingly, the ECB's balance sheet has expanded by
EUR 527 bn to EUR 2,539.5 bn since end-September 2014, mainly due to the asset
purchases and the four TLTROs.
For the PSPP we have been able to achieve all operational targets (i.e. announced quantities
and parameters of the asset allocation) and purchases have by and large not been disruptive
to market functioning. Since mid-April, however, volatility has risen markedly, reversing the
initial downward impact of the PSPP on sovereign bond yields. GDP-weighted euro area
sovereign yields are now roughly half a percentage point higher than the level reached on
the day of the PSPP announcement. But we need to be patient in assessing the significance
of these developments. Such a reversal of the downward trend in sovereign yields following
a QE announcement is common to other jurisdictions which undertook similar policies in the
past.
Our purchases of private assets have also proceeded relatively well. The CBPP3 has had a
strong downward impact on covered bonds spreads, which reached the tightest levels in the
last five years at the start of June this year. And though from mid-April yields have increased
in line with other fixed income assets, they have done so to a lesser extent. As a result, the
attractiveness of covered bonds has declined compared to government bonds, contributing
to an increase in the amount of offers available for CBPP3 purchases. This has helped the
smooth implementation of the programme thus far.
In terms of ABS, while the announcement and start of ABSPP led to a general compression
of spreads across all euro area countries, since mid-April the spreads of more stressed
jurisdictions have widened and moved above the levels prevailing at the start of the
programme. Even so, we understand that the ABSPP is seen as providing the asset class
with a credibility boost, which should in turn contribute to revitalising simple and transparent
securitisation and reducing its stigma among investors - a key objective of the programme.
We have also recently had some encouraging re-openings of public issuance across a
broader set of euro area countries, which could invite other issuers to follow up.
What ultimately matters from a monetary policy perspective, however, is not how well we
achieve our operational targets but how much our interventions are reflected in a reduced
cost of borrowing for firms and households. Here we see a positive impact from the APP on
both the bank and market finance. The cost of market-based debt has followed a downward
trend since end-2011 and stabilised at historically low levels in February-April 2015, before
rising again somewhat in May (+16 bp) and June (+20 bp). Market-based financing flows
have nevertheless continued to increase in recent months, implying that the lower cost of
market-based finance has had an important "first order" monetary policy effect.
On the bank side, the APP seems to have been effective in further reducing wholesale
funding costs, as portfolio rebalance effects have led to a compression of, for example, bank
bond yields. Consequently, while the cost of borrowing from banks for households and firms
has been declining since mid-2014, the pace of the decline has increased in recent months.
In April, the composite bank lending rates for households for house purchase and for
nonfinancial corporations stood at 2.25 and 2.30%, respectively 61 and 49 bps below the values
observed in June 2014. These developments reflect both the effect of the APP and of the
previous measures taken in the summer of last year.
While it may be too early to see a clear upward effect in terms of quantities, there are several
signs that the APP is also contributing to an easing of credit constraints in the euro area. For
instance, according to the Bank Lending Survey (BLS) banks have indicated that they intend
to react to APP purchases primarily by granting loans. In addition, banks in the survey expect
capital gains and a slight improvement in their capital ratios from the APP which could
support an expansion of lending, notwithstanding their expectations of a negative impact of
the programme on net interest margins and overall profitability (due to sharp flattening of the
term structure in a QE environment).
It must be noted, however, that banks' expectations that the APP will negatively impact
profitability do not seem to be aligned with either market evaluations or our own internal
appraisals. Market studies suggest that, on average, monetary policy news that is expected
to lead to a flattening of the yield curve causes an increase, rather than a decline, in banks'
share prices. This is confirmed by estimates of the impact of the APP on banks' profit and
loss accounts and their solvency situation performed by ECB staff. The overall effect on bank
capital is found to be positive, as capital gains on securities held, lower funding costs,
improved credit quality and higher intermediation volumes outweigh the negative impact of
the flattening of the term structure on net interest income.
In sum, it is fair to conclude that, thus far, the APP has been producing its intended aim of
easing of monetary and financial conditions, including in the context of heightened volatility
since mid-April. The very short end of the curve - because of expanding surpluses of liquidity
- has remained well-anchored around levels that are broadly in line with our forward
guidance over those horizons. We note however that the expected policy rate path implied by
markets has shifted up and steepened noticeably in a context of market re-pricing. Still, at
present we judge that the recent strong fluctuations in financial markets have not materially
altered money and credit dynamics, but close monitoring and continuous assessment are
warranted from a monetary policy perspective.
Moreover, to ensure sufficient predictability for markets and citizens about our future policy,
we have provided communication on our reaction function. We have underlined that the APP
is intended to run until the end of September 2016 and, in any case, until we see a sustained
adjustment in the path of inflation. Our monetary policy stimulus will stay in place as long as
needed to deliver our mandate on a truly sustained basis.
In addition, we have broadened and refined our arsenal of instruments during the crisis
years, and we have tested many of these instruments. Building on our past record, the public
knows that the ECB is determined to respond to disruptions in the monetary transmission
mechanism that would affect our price stability objective. Such disruptions could include an
undesirable tightening of financing conditions or a renewed surge in macroeconomic
uncertainty, with downside risks to inflation. In that case, we would make full use of the
flexibility afforded by the measures already in place and activate other policy instruments if
necessary.
We are not only willing to act, but capable of doing so. The recent ruling by the European
Court of Justice, while finding that OMTs fall within the scope of the ECB's mandate of
maintaining price stability, also stated clearly that the ECB must be allowed "broad
discretion" when preparing and implementing its monetary policy.
In short, we have the tools available, if needed, to ensure the appropriate monetary policy
stance for the whole euro area, and to react to specific impairments in the transmission
mechanism - if, as was the case in the past, such impairments were judged to undermine
the recovery and slow the process by which we anticipate inflation to return to levels closer to
2%.
Stability cannot however be provided by monetary policy alone. All policymakers have to play
their role in improving the functioning of monetary union, both by meeting their
responsibilities domestically and by fundamentally strengthening the euro area's common
institutions.