ECB enters damage limitation mode with pledge of more action

The European Central Bank’s chief economist has sought to soothe the disruption his president Christine Lagarde caused in government bond markets by saying that they “stand ready to do more” to contain any sovereign debt stress.

Italian government bonds suffered their biggest single-day fall for almost a decade on Thursday after Ms Lagarde said it was not the role of the ECB to “close the spread” in sovereign debt markets — referring to the spread between Italian and German bond yields that is a key risk indicator for Italy.

In an effort to reassure investors that the ECB was not leaving Italy to fend for itself, after the country went into lockdown to halt the rapid spread of coronavirus, ECB chief economist Philip Lane said in a blog post on Friday: “We will not tolerate any risks to the smooth transmission of our monetary policy in all jurisdictions of the euro area.”

“We clearly stand ready to do more and adjust all of our instruments, if needed, to ensure that the elevated spreads that we see in response to the acceleration of the spreading of the coronavirus do not undermine transmission,” he added.

Banca d’Italia governor Ignazio Visco followed up with a television interview on Friday, saying that the ECB could “front-load” purchases of Italian government bonds to ease any market tension.

“We can concentrate on particular jurisdictions according to the circumstances,” said Mr Visco, who is a member of the ECB governing council. “There is no question that if there are movements in the spreads caused by coronavirus, this will make more difficult our provision of liquidity and the impetus we are giving to the economy.”

Their words were felt by investors: Italy’s 10-year bond yield fell by 0.18 percentage points to 1.58 per cent on Friday, after rising by 0.6 percentage points on Thursday, which lifted its spread over German 10-year Bunds above 2.6 percentage points — almost a two-year-high. Bond yields rise when their prices fall.

Some investors have worried that the ECB was running out of ammunition to buy Italian sovereign debt just as concerns were rising about the economic impact of the virus, which has infected more than 15,000 Italians and killed over 1,000. Economists predict Italy will suffer a deep recession and a planned €25bn spending package will inflate its already high debt levels.

Mr Lane said the €120bn of extra asset purchases announced by the ECB this week — on top of its €20bn-per-month existing programme — “demonstrates that it is a priority for the eurosystem to show a more robust presence in the bond market during phases of heightened volatility”.

The ECB has a self-imposed limit to buy no more than a third of any government’s eligible debt — a limit it is close to hitting in some countries, such as Germany and the Netherlands. It is also bound to buy sovereign bonds in proportion to the relative size of each country’s economy and its contribution to ECB capital — known as the capital key.

But Mr Lane said the ECB would “use the full flexibility” of its asset purchase programme. “This means that there can be temporary fluctuations in the distribution of purchase flows both across asset classes and across countries in response to flight-to-safety shocks and liquidity shocks,” he said.

The ECB believes it is currently not constrained in how many bonds it can buy, so there is no need to change its self-imposed limits. Any potential pressure on the limits will be eased once countries issue more debt, as they are expected to do in response to the virus. The central bank plans to use most of its extra €120bn of bond-buying capacity to buy sovereign debt.

Ms Lagarde was widely criticised, including by the French and Italian presidents, after she said on Thursday that it was not the ECB’s role to address tensions in government bond markets. But in Germany her approach met with approval from Jens Weidmann, head of the country’s Bundesbank.

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