ECB Rate Decision Quick Analysis: Lagarde applies political pressure

• Main rates unchanged at -0.0%, 0.25%, -0.5%.
• Bank does not add to bond buying limits, PEPP stays at €750 billon.
• Lowers rates on targeted longer-term refinancing operations (TLTRO).
• Euro retains its recent edge against the dollar but broke no new ground.
• Italian and Spanish 10-year yields flat.

The European Central Bank kept its main interest rates unchanged -0.0% as widely expected but in a small surprise declined to increase its bond buying program, putting the decision off until at least the June 4 meeting.

There had been modest market anticipation that to help eurozone governments with the skyrocketing economic cost of the Coronavirus outbreak the bank would increase the limits of its pandemic emergency purchase program (PEPP).

EU and ECB politics

President Christine Lagarde and bank official have been trying to pressure the eurozone political leadership to provide fiscal support for the economy that could shrink 10% or 15% this year.  

Expect Ms Lagarde to be overtly dovish in her press conference.  She will no doubt promise that the bank is committed to supporting the eurozone economy until it recovers from the economic trauma of the Coronavirus pandemic. That may be enough to assuage any disappointment from the lack of new initiatives today.

The bank’s PEPP bond purchase program launched just five weeks ago and although it has already bought 125 billion in assets some European sovereign rates remain stubbornly high.  It has also expanded the acceptable types of collateral to some non-investment grade or junk securities from banks.

European politicians have been discussing a trillion euro reconstruction fund but so far have been unable to construct a deal. The bank may prefer to wait until the terms and funding of the fund are complete before raising the limit in its PEPP.

EUR/USD

The united currency moved slightly higher and then lower after the ECB announcement but within 30 minutes was at 1.0868  just off its pre-ECB level of 1.0878. In the longer term the fate of the fate of the euro depends more on the continent's success in curbing the Coronavirus and restarting the EMU economy than on specific amounts of ECB loan guarantees. 

EMU GDP

First quarter GDP fell 3.8% from the final three month of 2019, slightly more than the -3.5% forecast and the unemployment rate across the bloc increased to 7.4% from 7.3% as reported by Eurostat earlier today. 

Lockdowns began earlier in Europe with parts of the eurozone and Italy in particular closed down in mid- February so the economic impact was much greater. American closures did not begin until the third week of March and have not been universal with a number of states remaining open throughout.

European sovereign debt

Italy’s sovereign debt was downgraded by Fitch this week to just above junk status pressuring the borrowing costs of the eurozone’s third largest economy.  The yield on its 10-year bond has climbed 87 basis points to 1.78% in the past two months and was unchanged after the ECB announcement.

The Spanish 10-year yield was also flat at 0.77%.

Junk status for Italian debt would prevent the ECB from accepting its bonds as collateral.  But the bank and the EU political leadership is not about to abandon Italy and has been preparing to change or at least suspend the prohibition by accepting non-investment grade bonds from other sellers.

 The ECB is prohibited from funding national deficits but it is allowed to buy sovereign debt on the secondary market.  Many economists and so-called Northern politicians think that line is too fine to be meaningful.