Christine Lagarde triggered a bond market sell-off on Thursday as she launched a package of measures to alleviate the economic chaos caused by the spread of coronavirus, saying it was not the European Central Bank’s role to respond to movements in government debt markets.
Her comments came after the ECB announced it would expand its quantitative easing programme with €120bn of extra bond purchases, launch a new programme of cheap loans to banks and make the rates on its existing bank lending scheme more favourable.
“We are not here to close spreads, this is not the function or the mission of the ECB,” said Ms Lagarde. “There are other tools for that and other actors to deal with those issues.”
She also rebuffed suggestions that she sought to emulate the legacy of Mario Draghi, her predecessor as ECB president, saying that she did not seek to be “whatever it takes, number two”.
Her remarks “came across like the inverse of [Mr] Draghi’s ‘whatever it takes’” moment, said Rabobank strategist Richard McGuire, referring to Mr Draghi’s famous phrase, which was widely credited with calming the eurozone’s debt crisis in 2012 and bringing down Italian and Spanish yields.
After she spoke Italian sovereign bond prices fell by a record daily amount, widening the spread between the yields on Italy’s 10-year bonds and German 10-year Bunds — a key market indicator of concern about Italian sovereign risk — to more than 2.6 percentage points, its highest since June 2019.
Ms Lagarde later sought to clarify her remarks in a television interview, saying: “I am fully committed to avoid any fragmentation in a difficult moment for the euro area. High spreads due to the coronavirus impair the transmission of monetary policy.”
She added that the ECB’s latest easing package could “be used flexibly to avoid dislocations in bond markets, and we are ready to use the necessary determination and strength”.
George Saravelos, a strategist at Deutsche Bank, said that although the ECB’s package of measures delivered “above expectations”, Ms Lagarde’s “verbal execution was highly flawed”.
“The market is looking for comfort that Italy can make it through the crisis without having to be concerned about market access,” he said in a research note, adding that Ms Lagarde’s statement “gave the wrong signal”.
The ECB’s new stimulus package
What measures did the central bank announce?
The ECB kept its main deposit rate unchanged at its existing record low level of minus 0.5 per cent.
It said it would buy €120bn more bonds by the end of this year, on top of its existing commitment to buy €20bn a month. Economists estimate the scale of the ECB’s quantitative easing programme will rise to €33bn a month for rest of this year. Ms Lagarde said the additional asset purchases would be focused on corporate bond markets but the central bank would maintain flexibility in how it bought assets.
The central bank also said it would launch a new programme of cheap loans to banks to encourage them to keep lending to small businesses.
Its existing targeted longer-term refinancing operations will be made “considerably more favourable” by offering loans to banks below the ECB’s sub-zero deposit rate and as cheaply as minus 0.75 per cent. The decision makes the ECB the first major central bank to operate such a “dual rate” system, which in effect subsidises banks by lending to them at a lower rate than they pay to deposit money at the central bank.
In response to calls from banks for authorities to ease capital requirements to allow them to absorb the expected hit of the virus, the ECB said it would allow lenders to “fully use capital and liquidity buffers” that were designed to be eroded during times of stress.
Italy’s Five Star group of MEPs called the press conference “disastrous”, while one European official described her performance as “terrible”.
Mark Dowding, chief investment officer at BlueBay Asset Management, said: “The ECB needs to show leadership or it will undermine confidence in markets.”
Ms Lagarde’s mis-step came on the day she announced the first change in monetary policy since she took over at the ECB in November.
She sought to use the moment to pile pressure on European governments to do more with fiscal policy to shield the eurozone economy from the disruptive consequences of the virus.
After announcing the ECB’s latest monetary policy easing measures, Ms Lagarde spent much of her press conference urging eurozone governments to come up with an “ambitious and collective fiscal response”.
“What I’m particularly worried about, it would be the complacency and the slow-motion process that would be demonstrated by the euro area in particular,” she said, adding that she was hoping for a bigger fiscal response in the next meeting of eurozone finance ministers that takes place next week.
The ECB president stressed the response to the current economic crisis needed to be “fiscal first and foremost”, and said the spending pledges so far from eurozone governments amounted to only €27bn in total, or 0.25 per cent of GDP.
European stock markets plunged and Italian borrowing costs soared as markets were underwhelmed by the ECB’s easing package and the sell-off intensified during Ms Lagarde’s press conference. Many investors had expected a rate cut, or a bigger scaling up of the asset purchases programme.
“The market had been primed for a 2008-style response,” said Mr McGuire. “Instead what we got was the impression of the ECB not being in control.”
Ms Lagarde said coronavirus was “a major shock” to the eurozone’s growth prospects. There will be significant disruption to economic activity, particularly a slowdown in production and a reduction in domestic and foreign demand, she said, calling for fiscal action from governments.
“An ambitious and co-ordinated fiscal policy response is required to support businesses and workers at risk,” said Ms Lagarde, adding that the spread of the virus would have a “significant impact” on the eurozone and global economies, even if it was “temporary by nature”.
Pressure had been rising on the ECB to take action after the Bank of England and the US Federal Reserve announced emergency rate cuts and other measures in response to the economic impact of coronavirus in recent days.
Asked if the negative immediate reaction in markets indicated the ECB’s response was weak compared with other central banks, Ms Lagarde said it would be lending to banks at minus 0.75 per cent and buying an extra €120bn of bonds this year. She added: “I’m not sure you can so much rival that at the moment.”
Referring to her remarks about the spread between different sovereign bond yields across the eurozone, Frederik Ducrozet, strategist at Pictet Wealth Management, said central bankers “need to choose [their] words very carefully and unfortunately this is not only wrong, it is also a communications mistake”.
“It is the first time that market conditions have necessitated a follow-up interview by an ECB president to correct a statement,” he added.
Additional reporting by Sam Fleming and Miles Johnson
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