The Governing Council of the European Central Bank (ECB) met on 30 April, keeping policy rates unchanged as widely expected: the deposit rate at -0.50%, the main refinancing rate at 0%, and the marginal lending rate at 0.25%. The ECB made a further reduction to the interest rates on the TLTRO-IIIs by another 25bps so that banks can now take the funds at -1.0%. Additionally, a new series of seven pandemic emergency long term refinancing operations (PELTRO) were announced; monthly operations with maturities of around one year will be offered at the refi rate less 0.25%, commencing in May. It is a little unclear as to why this should be attractive to many banks, given that the TLTRO-IIIs are much more generous, so perhaps this can be considered as a safety measure. On the purchase programs, the ECB did not announce anything specific — no increase, no new assets and no extension, although ECB President Christine Lagarde made it clear that the ECB remains fully committed to support its euro members in all jurisdictions.
The ECB has adopted temporary measures to mitigate the effect on collateral availability, given possible rating downgrades. The decision complements the broader collateral easing package that was announced on 7 April 2020. Specifically, the Governing Council decided to grandfather the eligibility of marketable assets and the issuers of such assets that fulfilled minimum credit quality requirements (Fitch rating agency equivalent, not including ABS which is A-), in the event of a downgrade in credit ratings — as long as the ratings remain above a certain credit quality level (Fitch rating agency equivalent, with ABS to BB+).
Eurozone finance ministers, known as the “Eurogroup” managed to reach a compromise, with a joint economic response to the crisis delivering a €540 billion package. The package includes €240bn of potential ESM credit lines, €200bn of EIB guarantees and €100bn relating to the European Commission temporary unemployment reinsurance scheme, which will subsidise employees’ wages so that companies can cut wage costs without sacking workers. This dashed the hopes of Italy/Ireland/Spain plus six other members, who had called for Eurobond issuance. Germany, Finland, Austria and the Netherlands staunchly opposed joint debt issuance in the form of Eurobonds or “Coronabonds”, viewing it as unreasonable for them to guarantee the debts of other countries. They are next scheduled to meet on 6 May and the discussion between grants and loans is likely to be lively.
The ECB next meets on 4 June 2020.
With governments struggling to agree on joint fiscal action, the ECB has been actively purchasing bonds, supporting the peripheral countries in particular. Given the depth of the contraction, low inflation and falling inflation expectations, and the risk of a further widening of government yield spreads, we would expect the ECB to step up its PEPP (purchases up to the 24 April totalled €96.719 billion). The ECB is focusing on providing enough liquidity to the banking system and preventing further tightening of financial conditions.
Eurozone growth saw an unprecedented decline in the first quarter, with both the manufacturing and services sectors severely impacted. GDP declined -3.8% q/q in Q1, reflecting the downturn due to the lockdown. Of the eurozone countries that have released Q1 data, the declines varied from -2.5% in Austria, -3.9% in Belgium, -5.2% in Spain to -5.8% in France. Italy surprised with an estimate of -4.7% q/q, even though their lockdown started earlier. At the ECB press meeting, President Lagarde revealed expectations of a eurozone contraction for this year, ranging from -5% (the most optimistic scenario) to -12% (the most severe one). The ECB stated that revised projections would be announced at the June meeting.
Eurozone headline inflation decreased from 0.7% in March to 0.4% in April. The fall was largely driven by a fall in energy prices, but partly offset by a rise in food prices (+7.7% increase in unprocessed foods). The core rate (which excludes energy, food and tobacco) fell from 1% in March to 0.9% in April. Market expectations are for headline inflation to move lower, with a Bloomberg survey indicating expectations of 0.4% in 2020 and 1.2% in 2021. German inflation dropped to 0.8% y/y in April, the lowest reading since November 2016. In March, inflation was still at 1.4% y/y. One problem with current inflation data is that it is almost impossible to measure consumer price inflation when there hardly is any consumption.
Unemployment in the euro area showed a small increase up to 7.4% in March from 7.3% in February. This is not reflective as to what is likely to come from April onwards and expectations are for this to be much higher. Italy surprised with a decline in unemployment, distorted by a fall in the labour force. However, this could jump once the government lifts its ban on redundancies. There has also been a massive uptake of government furlough or “kurzarvbeit” schemes in the four largest eurozone countries (33 million people affected), which should prevent even bigger increases in unemployment.
Looking ahead, the effects of the coronavirus are a severe threat to global growth, dampening inflation and putting pressure on the labour markets.
The Euro Overnight Index Average (Eonia) averaged a yield of -0.45%, remaining stable over the month. Short-end cash was stable, trading 10–15 bps lower than Eonia. Excess liquidity deposited with the ECB increased over the month, reaching an historic high at €2.053 trillion on 30 April, averaging €1.996 trillion over the month. This follows the ECB’s fresh injections of liquidity with the weekly LTROs (announced at the March meeting) and the increase in asset purchases. Despite these injections, we have seen European money market term rates move higher. This was partly due to credit concerns pushing bank borrowing higher, and additionally due to the premium for floating rate euros over US dollars, with the positive cross currency basis. One-month Euribor averaged -0.428%, ranging -0.379% to -0.468% closing at -0.465%, approx. 4 bps lower than March; three-month Euribor averaged -0.254%, ranging -0.161% to -0.343%, closing at -0.273%, 10 bps points higher than March. Six-month Euribor averaged -0.192%, ranging-0.277% to -0.114%, closing at -0.17%; one-year Euribor averaged -0.108% to end the month at -0.118%, 12 and 5 bps higher, respectively.
Euro-denominated short-dated core government bills traded higher as supply increased, ranging from -0.66% to -0.47%. Three-month French Treasury bills ranged -0.56% to -0.45% in April, closing at -0.52%. Overnight government repo markets stabilised, ranging from -0.55% to -0.60%. Bank cash deposits were stable between -0.60% and -0.55% over the month.
Global government bonds were less volatile in April. Central banks and governments have launched unprecedented moves to provide liquidity and support to their economies as the threat from the spread of coronavirus escalates. Ten-year US Treasury yield stabilised, beginning April at 0.58% and closing higher at 0.64%, with a high 0.77% in the month; 10-year German Bund yields moved lower, beginning April at -0.46%, closing at -0.59%, with a high of -0.31%; 10-year UK gilt yields moved lower, beginning April at 0.31%, closing at 0.23%, with a high of 0.41%.
Italian debt continued to experience the most volatility among peripheral European bonds. Italian 10-year government bond yields closed April at 1.76%, compared to March at 1.52%. The high in April was 2.15% and the low was 1.46%. In an unscheduled rating update, Fitch rating agency downgraded Italy’s credit rating to BBB-, just one notch above junk on concerns about Italy’s debt sustainability. The ECB has shown support by actively purchasing bonds under PEPP and expanding its collateral credit parameters. However, Italy remains vulnerable as fears of further economic slowdown and concerns about debt levels remain.
At the fund level, the weighted average maturity (WAM) averaged 29 days in April. European money markets showed encouraging signs of recovery, with strong activity, as investor and market confidence returned. Investments were targeted out to one month, with selective investments out to three months. Short-term liquidity ratios remained high in both overnight and one-week maturities. Fund liquidity was covered with a combination of government and agency holdings, government/supranational repo and bank deposits. The fund always maintained a high credit quality.