ECB to Continue Stimulus Spending against Coronavirus until mid-2022

The European Central Bank surpasses barriers with the asset purchases made since March 13. The institution will increase its balance to 8 trillion.

Central banks continue to do their utmost with stimulus packages desperately needed by the economies and markets. Exploring if there are limits since the fall of Lehman Brothers and the euro debt crisis, the ECB has gone further the coronavirus. The institution has already deployed one trillion euros in asset purchases against the effects of the pandemic, which it considers will continue, at least, until March 2022. The monetary authority has announced that it will possibly inject another 1.5 trillion more into the market until then.

If it exhausts its programs without new changes, it will be 2.5 billion in two years to alleviate the pandemic's effects. The balance has already reached 7 trillion and is on track to exceed 8 trillion next year, a figure that contrasts with the 2 trillion it had at the beginning of the financial crisis of 2008. The European leaders finalize the Recovery Fund agreement to accompany monetary stimuli with public spending, as the monetary authority has been asking for years from Frankfurt.

The unprecedented crisis unleashed by Covid-19 has urged European leaders to act. The ECB action follows suit with other institutions such as the Federal Reserve (Fed).

Investors tend to buy negative bonds not to lose money. Be that as it may, the ECB allows Spain and the rest of the European states to spend more in a period of lower-income. This stems from the fact that Spain and other economies can spur activity or limit the damage with aid to families and companies, temporary employment regulation files or public guarantees to encourage bank credit. Hence the importance of the central bank. What the ECB has shown this week is that "it is massively positioned for a negative or bearish scenario," warns Alberto Matallán, chief economist at Mapfre Inversión, referring to the cut in the growth forecast for next year, from 5% of GDP to 3.9%. "It is time for fiscal policy. From here, and with the economic data in hand, no further monetary stimulus seems necessary. Moreover, without coordinated fiscal action, it can cause imbalances," he adds.

Limits to monetary policy?

The monetary authority has never recognized that it has touched limits, although interest rates seem apparent. The ECB reached this crisis with reference rates at 0%, and deposit rates penalize banks' excess liquidity, at -0.5%. There is a concept known as the 'reversal rate,' which is the 'money price' level from which further lowering rates would be counterproductive. 

The ECB has implemented a financial crackdown in which any hint of inflation makes conservative savings lose purchasing power with negative real interest rates. This year it forecasts a CPI of 0.3% for 2020 and 1% for 2021, enough to exceed the returns on deposits and the safest investments in fixed income. There is always the risk that monetary stimuli will generate inflation. It is an old criticism that began in 2008 and has been losing strength because there have not been significant increases in consumer goods prices. Will central banks generate inflation tensions this time? There are doubts in the market. "In the short term, we do not see an inflation problem because the fall in economic activity as a consequence of the crisis means that almost all economies are operating well below their potential," argues Emilio Ortiz, investment director of Mutuactivos.

Liquidity trap

There is a part of saving stored in deposits and checking accounts, which is explained by two aspects. Temporarily, there is consumption contained by restrictions on mobility in recent months and concern about the recession, with increases in the savings rate. Structurally, the effect of the liquidity trap that Keynes alluded to almost a century ago is observed: too low rates prevent conservative investments from attracting money from checking accounts. Thus, the ECB has focused since the beginning of the pandemic on providing liquidity to the economy and the markets to avoid a credit crunch or restrictions that amplify the economic shock. In fact, there were liquidity problems in fixed income in the first weeks of confinement, which did not worsen thanks to the central bank's liquidity deployment. 

This figure includes all available programs. And on them, the ECB has announced a pending perimeter of 1.5 trillion. The monetary authority extended this Thursday the purchase period, at least until March 2022. It assumes that there will be at least two years of economic effects due to Covid-19. For this recession, the ECB created a special program against the effects of the pandemic with 750 billion EUR. The 500 billion EUR component announced on December 10 came on top of the June injection of 600 billion, adding up to 1.85 trillion EU. So far, it has injected into net asset purchases, which include sovereign and corporate bonds. This new package gave more importance to corporate debt, which the ECB had already been buying but to a much lesser extent than sovereign bonds.