As infections rise, European Central Bank prepares stimulus

The European economy should get another boost from the European Central Bank on Thursday

Germany Daily Life (Copyright 2020 The Associated Press. All rights reserved)

The European Central Bank is expected to unleash another blast of stimulus on Thursday to help businesses bridge the gap until the economy recovers from the pandemic - and to support governments that are ramping up spending to cushion the blow as the winter wave of the virus worsens.

The bank could add a half-trillion euros or more to its existing bond purchases. That means the central bank will vacuum up much of the new debt being issued by hard-pressed governments lowering the risk of a new eurozone debt crisis.

If the pandemic purchases are expanded as expected, and combined with a previous bond purchase program amounting to 20 billion euros ($24 billion) per month, the ECB “will continue to absorb a very large part of gross debt issuance from euro area states,” wrote Frederik Ducrozet and Nadia Gharbi at Pictet Wealth Management.

Bond purchases drive down borrowing costs in the bond market, where governments get their financing, and thus takes some of the financial pressure off governments that otherwise might restrict their spending at the worst possible time.

Analysts Chiara Cremonesi and Francesco Maria Di Bella at UniCredit bank say that the ECB will remain “extremely active” in the bond market: “Indeed, we expect the ECB to purchase an amount similar to the entire new net issuance in 2021.”

They estimate the 19 countries that use the the euro will issue some 1.3 trillion euros in medium and long-term bonds next year, covering new deficits and existing debt.

Analysts view action at Thursday's meeting as all but certain. ECB President Christine Lagarde said at the Oct. 28 meeting that there was “little doubt” that the 25-member governing council would conduct a “recalibration” of existing stimulus programs at the December meeting. She subsequently pointed to the current, 1.35 trillion ($1.58 trillion) pandemic emergency bond purchase program as a likely place for action. Analysts think the council could add 500 billion euros or more to the purchases, and extend their duration to the end of 2021 or to mid-2022. Currently the purchases are slated to run until mid-2021, or until the end of the COVID-19 crisis phase, whichever comes first.

The bank could also add to its cheap, long-term loans to banks. Those credit offerings help ensure that bank finances are not cramped by the pandemic and that they can keep lending to businesses.

The winter surge in infections puts the eurozone in a difficult situation. Forced closure of bars and restaurants for in-house dining and limits on gatherings mean that the economy will probably shrink in the last three months of the year.

Governments are spending heavily to keep businesses afloat until they can reach the other side of the pandemic downturn. Forms of aid include furlough support programs that pay most of workers' salaries if they are put on short hours or no hours instead of being laid off, loans, and tax breaks and deferrals, such as Germany's temporary cancelling of value-added tax.

On top of that, governments have joined together to add fiscal stimulus at the European Union level, backed by common borrowing to create a 750 billion euro recovery fund to pay for digital innovation and efforts to create an economy that produces less carbon dioxide, the primary greenhouse gas blamed for climate change. That money is set start flowing early next year as part of the EU's multi-year budget. At the moment, Poland and Hungary are blocking the recovery fund because the money comes attached with conditions requiring adherence to the EU's standards for rule of law.

At the national level, government spending means bigger deficits and debt piles - not an irrelevant issue in the eurozone, where a rise in governments' market borrowing costs threatened to break up the currency union in 2010-2012. The size of Italy's debt pile is expected to rise to 170% of annual gross domestic product, from 135% at the end of 2019.

Yet its borrowing costs remain low and markets are calm despite the pandemic, and analysts say ECB support plays a crucial role in that. In a report published by the Bruegel research institute in Brussels, analysts estimate that ECB support will continue to be essential to keep Italy's debt from exploding into another crisis.

So long as the ECB keeps a lid on debt costs, “the Italian debt trajectories are stabilized at a high level and return to the pre-COVID-19 levels within a decade," wrote Andrea Consiglio, professor of mathematical finance at the University of Palermo, and Stavros Zenios, professor of finance at the University of Cyprus. Without ECB support, a debt crisis could loom.

Assuming the dispute with Hungary and Poland is resolved, the amounts of EU aid will boost growth but “will have only a small impact on debt dynamics,” says Melanie Debono, Europe economist at Capital Economics.

“For the time being it will continue to fall on the ECB to ensure fiscal sustainability.”