ECB’s coronavirus response fails to rally markets

The European Central Bank (ECB) joined other central banks around the world in announcing new monetary stimulus to help the economy cope with the coronavirus outbreak.

The ECB announced new liquidity measures designed to act as a backstop if the financial system is to experience difficulties, and also to boost lending to small and medium sized enterprises.

These will be conducted using a new long-term refinancing operation (LTRO), and a new targeted long-term refinancing operation (TLTRO3).

The ECB also announced an additional envelope of €120 billion of asset purchases (or quantitative easing), which can be used by the end of this year.

Markets toil

Despite the ECB’s action, markets have not responded favourably to the announcement.

The yield on Italian government bonds has risen (prices fallen) as investors sell their holding of Europe’s most vulnerable bond market.

We believe that markets were looking for a cut to interest rates, which the ECB failed to deliver.

Banks showing "no stress"

While the additional liquidity to banks is sensible, banks are already awash with liquidity, and as ECB President Lagarde mentioned in the press conference, there have been no signs of stress so far in the functioning of banks.

The additional quantitative easing is also useful; however, the ECB has not abandoned its issuer limits and capital key, which means that it cannot focus the €120 billion of QE on the markets that need it the most (namely Italy).

Fiscal policy needed

The abandonment of the capital key would have boosted the market’s confidence, but at the same time would mean the ECB would be in the realms of monetary financing, which is illegal under its current mandate.

Ultimately, the ECB’s power is very limited. Co-ordinated fiscal policy must now take the lead in order for the appropriate policy tools to be introduced to support struggling households and businesses.