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The European Central Bank didn’t sit on its hands Thursday, but it didn’t pull out the stops either.
As expected, the ECB left its policy interest rates unchanged at its meeting. It also took steps aimed at boosting liquidity in the banking sector, lowering the interest rate on an existing program of long-term refinancing operations while introducing a second program of long-term loans.
But the ECB made no changes to its €750 billion pandemic emergency purchase program, or PEPP, that was introduced just last month, or to other asset-buying programs, though ECB President Christine Lagarde said that policy makers were ready to expand and adjust those programs if needed.
Lagarde “paints a picture of a central bank that is in full-on emergency mode, and which has had to throw out the rulebook for both policy and standard forecasting. That sounds about right to us,” said Claus Vistesen, chief eurozone economist at Pantheon Macroeconomics, in a note.
While ECB staff aren’t due to issue revised projections until June, Lagarde said they see the eurozone economy contracting between 5% and 12% in 2020, an “unprecedented” decline whose magnitude will depend on the length and effectiveness of the lockdowns. That’s not out of line with other projections. The International Monetary Fund, for example, has projected a 7.5% contraction for the eurozone.
Earlier Thursday, Eurostat reported eurozone first-quarter GDP fell 3.8% compared with the fourth quarter. European data is reported on a quarter-on-quarter basis unlike the U.S., so on an annualized basis, the economy fell 14.4%, worse than the annualized U.S. gross domestic product decline of 4.8%.
Inflation across the eurozone dropped to a 0.4% annual rate in April from 0.7%, well below the ECB’s target of near but just below 2%.
For now, “the ECB is trying to support the eurozone economy mainly through ensuring there is enough liquidity and extremely favorable financing conditions for the banking sector, as this is key in providing credit to the real economy,” said Carsten Brzeski, chief eurozone economist at ING, in a note.
Longer-dated Italian government bonds rallied and then retreated after the ECB policy update, but shorter tenors performed better on expectations that such maturities would benefit from the central bank’s newly announced pandemic long-term refinancing operations. The 10-year Italian government bond yield TMBMKIT-10Y, 1.772% was up a basis point to 1.78%, widening its spread versus the equivalent German bond TMBMKDE-10Y, -0.588% by 10 basis points to 2.35 percentage points. The 2-year Italian note fell 5 basis points.
The euro EURUSD, +0.48% rose 0.6% versus the dollar to $1.0943.
Meanwhile, Lagarde emphasized that the ECB wouldn’t tolerate “fragmentation” in financial markets that would inhibit the effects of its monetary policy efforts in parts of the eurozone.
“This is ECB-speak for saying that the central bank is indeed here ‘to close the spreads’ and that it intends to do just that,” Vistesen said. Lagarde in March roiled financial markets when she said the ECB’s job wasn’t to “close the spreads,” remarks that she quickly walked back amid criticism.
