ECB Adds To QE, European Credibility On The Rise

The European Central Bank has increased the size and duration of its Pandemic Emergency Purchase Program. The envelope for asset purchases was increased by 600 billion euros ($674.5 billion), to 1.35 billion euros and the program will now run to the end of June 2021, compared to the end of 2020.

Shaky Start

This comes after an initial shaky start for the Presidency of Christine Lagarde, the former head of the IMF, whose first ‘crisis’ press conference was marked by her statement that she did not think it the role of the ECB to ‘reduce spreads’. The intention of Lagarde in making that remark was to underline her desire that European governments bear more of the responsibility for stimulating growth and building out the euro-zone. Indeed since she has taken office her mantra has been that ‘governments must do more’.

In this respect the coronavirus crisis has managed to do what years of a euro crisis has not achieved – deepen the financial capacity of the EU. Under a bold new plan, the EU will launch a Eur 750bn stimulus package – equally nearly 2% of EU gdp over three years. The ‘Recovery and Resilience’ package is made up of Eur 60 bn in guarantees, Eur 250bn in loans and Eur 440bn in grants.  

New Plan

From the point of view of international investors, this is a new departure, and there are several points to be aware of. The first is that the EU itself, rather than individual governments will borrow in the capital markets to fund the package. This is noteworthy because it gives the EU fiscal or financial capacity, in somewhat the same way that the dollar came into being. Equally, the EU will now raise revenues with taxes envisaged on carbon and financial/digital transactions. Another important element is that this plan has been driven by the Franco-German political engine – the crucial motivator of change and political progress in Europe.

Markets are already reacting. The euro has rallied over three percent to the dollar and European equity markets are up 20% over the last month. There may be more to go. It seems that whenever there is a macro or financial crisis, or whatever making, one knee-jerk reaction in London or New York is to presume the collapse of the euro-zone.

No Italexit

Many commentators rightly point to the indebtedness and low level of growth of Italy and declare it an inevitable faultline. Italy is not the UK in that testy responses to surveys on Europe do not automatically mean an Italexit (legally nearly impossible).

The new EU fiscal plan and the additional buying by the ECB will rein in periphery spreads. They may also mean that with US markets (NDX, SPX) at very high valuations, international investors will look at the DAX and CAC40. More importantly, the euro now has a bid, taking some of the strength out of the dollar, a trend that will help global risk appetite.