ECB to delve into what ‘favourable financing’ means as questions mount: sources

FRANKFURT (Reuters) – European Central Bank policymakers are set to delve deeper at their next meeting into how they measure borrowing costs in the virus-hit euro zone economy after failing to reach an agreement this week, four sources told Reuters.

The ECB has pledged to maintain “favourable financing conditions” to help the bloc recover from the economic shock of the pandemic, but it has never spelled out how those are measured.

The issue is crucial as it determines how many bonds the ECB will buy under its pandemic-fighting scheme, which is the object of some market speculation after the bank said on Thursday it did not need to exhaust its 1 trillion euros of remaining firepower.

Policymakers will hold a seminar at their March 10-11 policy meeting and debate which indicators should be included, whether they should be looked at individually or condensed into an index, and how this should be communicated — if at all, the sources said.

Not all policymakers are convinced about the merit of an index as that would tie their hands by preventing them from focussing on stresses that may be building only in certain corners of the economy, one source said.

And the notion of making that information public is also making many nervous in light of recent history, some of the sources added.

Former President Mario Draghi made a rod for his own back by elevating a certain market-based measure of long-term inflation expectation as the ECB’s favourite, causing market participants to obsess about it and ultimately reducing its informative value.

An ECB spokesman declined to comment.

President Christine Lagarde raised more questions than answers on Thursday when she said the ECB was not just looking at the bond market, but rather making a “holistic assessment” of “multiple indicators” without elaborating.

Lagarde was trying to bat back suggestions the ECB was actively capping bond yields or spreads but she could not be more specific as policymakers at the Jan. 20-21 policy meeting did not reach a conclusion after extensive discussions, the sources said.

Rate-setters also disagreed on whether the euro zone’s economy was still facing predominantly “downside risks” but those taking a more optimistic view were in a minority, the sources said.

PEPP ENVELOPE

Some policymakers believe that government bond spreads — that is the premia that more indebted countries pay compared to safe-haven Germany — and bank lending rates were the two most relevant indicators at present, one source said.

Indeed they were the only two mentioned by Lagarde during her press conference.

But that failed to reassure investors, with spreads between Italian and German bonds widening on the perception that the ECB was less committed to using the whole envelope earmarked for its Pandemic Emergency Purchase Programme (PEPP).

Lagarde had said “if favourable financing conditions can be maintained with asset purchase flows that do not exhaust the envelope over the net purchase horizon of the PEPP, the envelope need not be used in full”.

But the sources said this was not meant to be a new policy signal as she had already said the same in December and the inclusion of that sentence in the ECB’s press release accompanying the policy decision had not been discussed by the Governing Council.

ECB Chief Economist Philip Lane has often cited the difference between 10-year bond yields issued by euro zone governments and the overnight index swap rate paid by banks to finance themselves on the money market as a useful alarm bell on financing conditions.

When that spread widened in March, the ECB responded by buying large amounts of government bonds issued by Italy, the euro zone country hit hardest by the first wave of the coronavirus pandemic.

In a speech in June, Lane also drew attention to an index of financing conditions based on money market rates, the euro’s exchange rate and euro zone equity prices.