During its Monetary Policy Committee meeting on 10 March, the ECB made some important decisions.
1. It announced cuts to its three key interest rates:
• the refinancing rate was cut by 5 basis points to 0.00%
• the rate on the deposit facility was cut by 10 basis points to -0.40%
• the rate on the marginal lending facility was cut by 5 basis points to 0.25%
2. It extended its targeted longer-term refinancing operations (TLTRO) by four years.
3. It boosted its QE programme, now injecting 80 billion euros per month (versus 60 billion euros previously), thereby adding 240 billion euros in purchases. The programme is now equal to 18% of the eurozone’s GDP.
4. Most importantly, the ECB will expand its bond purchases to include investment-grade non-financial corporate debt, starting at the end of the second quarter.
The ECB’s aim was to show that the central banks are not running short of ammunition. These are drastic moves: they go further than consensus analysts had hoped. Bond yields should decline across the board and remain low.
The segment of investment-grade non-financial corporate debt accounts for some 400 billion euros of the 1.5-trillion euro corporate-debt market (see left-hand chart). This market is large enough to allow the ECB to make substantial purchases but, somewhat paradoxically, small enough that these purchases will serve to compress investment-grade corporate spreads (see right-hand chart).
The ECB's purchases could amount to 50-100 billion euros per year. Even if its action stimulated an increase in issuance by speeding up financial disintermediation, upward pressure will be placed on prices and downward pressure on nominal yields. Issuance volumes are currently just above the amounts that the ECB could purchase (see left-hand chart below).
If the ECB’s purchases are proportional to the Member States’ respective supply, France, the Netherlands, Belgium and Ireland stand to benefit the most (see the blue bars in the right-hand chart on the previous page). Companies in these countries seek financing on the bond markets more than Italian and Austrian companies, for example, which tend to prefer bank loans. But if the ECB's purchases are scaled to the size of each country in the eurozone, the advantage would be reversed (see purple bars in the chart).
Up until now, the ECB has taken the first approach in its purchases of covered bonds and asset-backed securities. For the purchase of sovereign bonds, it chose the second approach for political reasons. This is because, under its mandate, the ECB is strictly forbidden to finance Member States' debt. To avoid entanglement with the Karlsruhe court, it buys sovereign debt on a non-discriminatory basis.
The current situation is not related to sovereign debt, however. There is thus good reason to believe that the ECB will take the first, pragmatic approach that is based on the supply of bonds available on the market. As it did for other private-sector assets, it will not publish the regional breakdown of its corporate bond purchases.
Mario Draghi and the ECB governors chose this form of monetary loosening in order to improve debtfinancing conditions for investment-grade companies in the eurozone. In recent months, spreads tended to anticipate the challenging economic situation, which is bordering on recession. Unlike the equity market, which is still relatively optimistic, the bond market is generously rewarding the risk taken by investors (see chart above). The ECB’s latest move has shaken things up: it is offering a rare opportunity to benefit from narrowing investment-grade spreads in euros.