ECB governors agreed on size of bond purchases, less on composition

ECB minutes usually come four weeks after the respective meeting, but yesterday the central bank also released the minutes of its video conference three weeks ago that launched the €750bn pandemic emergency purchase programme. Most interesting to us in this double serving are: how the governing council's economic outlook evolved in the first week of European Covid-19 lockdowns, and any differences of opinion among governors on policy.

Even recognising that its own staff forecast was already outdated and uncertainty on the downside was high, the March 12 meeting still considered rather benign scenarios. The baseline scenario foresaw a 0.3% drop in 2020 GDP, while a mild scenario put the drop at 0.6-0.9% and a severe scenario of 0.8-1.4%, all of them without fiscal or monetary response. This is extraordinarily optimistic. Data from China, and now from eurozone countries, suggest it is reasonable to expect a 30-35% drop in economic activity due to lockdowns. This means 0.6-0.7% GDP drop per week of lockdown, assuming the economy then bounces back to the previous level of activity. Still, even the milder assumptions warranted a strong policy response and governors agreed unanimously in both instances. Any disagreement was on the details.

At the March 18 meeting there was consensus that the economic situation, not to speak of markets, was already deteriorating rapidly and there was a significant risk of recession. The deflationary effect was being compounded by the drop in oil prices. Isabel Schnabel, in charge of markets, reported a generalised widening of spreads even as the benchmark German bond yield had risen. The intense flight to safety had widened spreads of even highly-rated eurozone governments. Corporate bond spreads had also widened.

As to policy, even in the calmer environment of the first meeting, governors were clear they needed to ensure that a temporary disruption of cash flows didn't lead to balance sheet problems in the corporate and banking sectors, and therefore to a broader financial crisis. Everything possible must be done to prevent the lasting damage to the economy that this would cause. Points made about the policy package include that monetary stimulus would only be really effective once the spread of the coronavirus had been contained, and therefore in the short term the fiscal response was very important. It was even suggested that relaxing the conditions of the TLTRO III funding-for-lending programme, so that overall lending volumes didn't need to increase, might not be enough if banks were forced to actually reduce their credit exposure. We note that the supervisor relaxed banks' capital and liquidity constraints as much as possible to prevent this, but as governors noted there could still be intense market pressure on banks.

Adding volume to asset purchases was preferred to lowering rates, given the cost of long-term refinancing operations had been lowered substantially. It was important that the expansions of asset purchases were on a yearly basis, not monthly. This would allow government bond purchases to be concentrated on the markets under more stress in the short term, with convergence to the capital key in the latter part of the year when hopefully the crisis would have abated. At the March 18 meeting there were reservations expressed on the need for a new asset purchase programme. While not questioning the proposed amount of new purchases, some felt they could equally have been carried out under the existing asset purchase programme, or even under the OMT. We would note that OMT cannot be launched at will, it is conditional on the target country being under an ESM programme, so that wouldn't have been an appropriate tool. These sceptical governors seem to have wanted to ensure adherence to the capital key, which in the end would be applied flexibly.