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European stimulus

Faced with rising borrowing costs for EU governments, the ECB says it will increase the pace of stimulus

European GDP is set to shrink further in the first quarter of the year, says ECB President Christine Lagarde.

THE EUROPEAN CENTRAL Bank has announced that it will accelerate the pace of bond-buying in the second quarter of the year to stave off a rise in borrowing costs for European governments.

The central bank also announced that interest rates will remain unchanged, leaving its deposit rate at -0.5%.

In recent weeks, euro area governments have faced increased debt and refinancing costs as a result of rising bond yields.

Despite increased scrutiny of European government debt markets in recent weeks, the ECB has not meaningfully increased the pace of bond-buying. Recent figures suggested that the pace of purchases actually slowed down last week amid a US government bond sell-off, which spilled over into European debt markets.

But the ECB now says that it will increase the speed of asset purchases under its flagship pandemic-era initiative, the €1.85 trillion Pandemic Emergency Purchase Programme (PEPP).

In a press statement this afternoon following its regular monetary policy meeting, the Governing Council of the ECB said, “Based on a joint assessment of financing conditions and the inflation outlook, the Governing Council expects purchases under the PEPP over the next quarter to be conducted at a significantly higher pace than during the first months of this year.”

European bond yields have edged lower since the announcement.

Money printing

Rolled out last April when the euro zone was initially plunged into a deep recession, the main goal of the PEPP is to keep down borrowing costs for member states low to prevent a pandemic-linked credit crisis within the single currency area.

The strategy is to print money and use it to buy up large tranches of mostly government bonds — IOUs from governments to investors — to create a baseline of demand for extra debt issuances by euro area member states.

It helped prevent the likes of Italy and Spain — both of which have high levels of historic debt — from being shut out of international debt markets at a time when they need to borrow to fund emergency government programmes.

The ECB also snapped up more than half of the €21.5 billion in Irish government bonds issued in 2020.

But in recent weeks bond yields have edged upwards. Many investors in government debt have ditched their holdings, betting on an increase in price inflation in the medium term as economies reopen on foot of a successful vaccine rollout. Inflation eats away at the value of debt holdings.

In recent weeks, inflation concerns forced a bond sell-off, which reduced their price. Bond prices and yields — which reflect the return to the investor — move in opposite directions.So as more and more bonds hit the open market, yields rose. 

High demand for bonds (ie higher prices and lower yields) mean lower borrowing costs for the government that issued the security.

Speaking after the Governing Council meeting today, ECB President Christine Lagarde said rising bond yields “if left unchecked… could translate into a premature tightening of financing conditions for all sectors of the economy”.

Lagarde also announced that the ECB has upwardly revised its inflation projects for the coming year.

“Inflation has picked up over recent months, mainly on account of some transitory factors, and an increase in energy price inflation. At the same time, underlying price pressures remain subdued in the context of weak demand and significant slack in labour and product markets,” she said.

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