Stability of the Eurozone Relies on the ECB’s Drip-Feed

The fact that the government bond markets within the eurozone have remained stable throughout the coronavirus pandemic is especially owed to the ECB and its PEPP securities purchase programme. By contrast, the EU coronavirus financial aid packages have not made any measurable contribution to narrowing interest rate differentials. This is confirmed by a study conducted by ZEW Mannheim with the support of the Brigitte Strube Stiftung.

As part of a so-called ‘event study’, the authors investigate how different types of announcements have affected the spreads of government bonds within the eurozone relative to the interest rate of German federal bonds. Crisis measures by the ECB as well as decisions by the EU regarding supportive measures such as the SURE loan programme (temporary Support to mitigate Unemployment Risks in an Emergency) or the coronavirus recovery programme – ‘Next Generation EU’ – with its credit-financed expenditure totalling 750 billion euros have both been taken into consideration. The study also examines how announcements made by the European Commission on the suspension of the deficit limits under the European Stability Pact and the decision to appoint Christine Lagarde as president of the ECB in summer 2019 had an impact on the government bond spreads.

The results show that the PEPP securities purchase programme launched by the ECB in March 2020 had an overwhelming influence on the narrowing of spreads. In contrast, other monetary policy announcements such as the initial expansion of the older PSPP purchase programme were ineffective or even caused more uncertainty. “The PEPP, which lifted caps on purchases of the government bonds of highly indebted euro states, was the real game changer,” says co-author Justus Nover, a researcher in ZEW’s “Corporate Taxation and Public Finance” Department.

Although the EU launched various types of new financial assistance in the course of 2020, such as SURE and Next Generation EU, announcing these didn’t have a discernible impact on the bond markets. Only for Italy is a statistically weak effect observable. On the other hand, announcements by the European Commission to suspend the Stability Pact with its deficit limits have rather caused growing uncertainty. The markets tended to respond to this information with rising spreads.

The event study also examines how, before the pandemic, the decision by the European Council to appoint Christine Lagarde as president of the ECB and Ursula von der Leyen as president of the EU Commission was received on the bond markets. The announcement of this surprising personnel decision led to a decline in spreads for southern European bonds in the summer of 2019. The authors see this as evidence that Lagarde is perceived as being more in favour of extensive aid for heavily indebted states at the helm of the ECB than Bundesbank President Jens Weidmann, who had previously been discussed as a candidate.

The results indicate that the stable financing situation of the peripheral euro states in the pandemic is primarily due to the ECB’s extensive crisis aid, which benefits highly indebted euro states disproportionately. “According to our findings, the stability of the eurozone relies on the drip-feed of the ECB. The fiscal packages so far have not yet led to any noticeable relief for the ECB. The ECB will probably continue to be forced to take the liquidity of heavily indebted euro states into account in its monetary policy decisions. Thus, our insights provide evidence that the concern about a fiscal dominance of the ECB is not unwarranted,” concludes ZEW researcher Professor Friedrich Heinemann, who is responsible for the study.