The European Central Bank’s emergency bond-buying programme is the equivalent of a tremendous kick that sends the can skittering down the road. The risk of a credit crisis has been averted — temporarily. The fall in eurozone bond yields is a relief rally that will not last.
Blame Italy. Everyone else does. Before the ECB announced its new bond-buying plan, the country’s borrowing costs were soaring. The gap between bond yields in Italy and Germany had widened — an acknowledgment of realistic differences in country credit risks amid the coronavirus outbreak.
Italy has accumulated more than €2tn in public debt — equal to nearly 135 per cent of its GDP. German debt is equivalent to 62 per cent of economic output. Italy has never relinquished the original sin of the last financial crisis. Domestic banks and sovereign debt remain dangerously entwined.
The ECB’s €750bn Pandemic Emergency Purchase Programme has done the job for now, spurring a rally in bonds. The spread between Italian and German 10-year bond yields fell from 253 basis points on Wednesday to 190 basis points on Thursday morning. Backslapping all round.
ECB president Christine Lagarde claimed this month that it was not the central bank’s job to narrow sovereign spreads. But the ECB had to try. Italy can ill-afford high borrowing costs in the midst of a crisis. The country’s rightwing politicians already bristle against eurozone membership. A messy exit raises the spectre of a vast sovereign debt default.
The ECB’s decision to make its bond-buying programme “flexible” is also the right move. Expanding eligible assets and raising the possibility of an end to debt purchase quotas shows commitment. Ms Lagarde’s claim that “there’s no limit” to the ECB’s support of the euro is designed to sound like predecessor Mario Draghi’s effective “whatever it takes” motto to support the eurozone in the last financial crisis.
Yet the market effects of ECB, Bank of England and US Federal Reserve support may be short lived. Cash will remain alluring. Low interest rates and asset purchases were already in place. Central banks have upped the ante, not changed the game.
Without a clearer timeline for the attenuation of the pandemic, conventional investment is impossible. There is no signal, only noise. The ECB’s existential question remains unanswered: does Europe have the stomach to take on Italy’s debt burden?
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