ECB prepares more aid for virus-stricken euro zone

Balazs Koranyi and Francesco Canepa
FILE PHOTO: Specialists work on a crane in front of the European Central Bank (ECB) in Frankfurt

By Balazs Koranyi and Francesco Canepa

FRANKFURT (Reuters) - The European Central Bank is certain to give the ailing euro zone economy another shot in the arm and the only question is the timing, with arguments split between a move on Thursday and holding out until July.

As a coronavirus-induced recession runs deeper and longer than expected, governments are running record deficits to cushion the impact, putting a greater burden on the ECB to soak up this new debt and keep borrowing costs manageable.

The ECB has made it clear it will do its part and the severity of the recession argues for earlier action. But a still-elusive political deal on European Union-wide fiscal support strengthens the case for patience.

"Arguments for and against scaling up the stimulus are finely balanced," Berenberg economist Holger Schmieding said. "On balance, we see a 60% probability that the ECB will raise its asset purchase target on Thursday, probably by 500 billion euros (446.8 billion pounds)."

Interest rates are almost certain to stay unchanged as the ECB's minus 0.5% deposit rate is already at a record low and many policymakers feel further moves would be counterproductive.

The German Constitutional Court's recent ruling that the ECB has exceeded its mandate and the Bundesbank must quit a key bond purchase scheme, may add to the case for acting earlier.

Defying the ruling, the ECB said the German court lacks jurisdiction over its policy decisions. A big move on Thursday could ease fears that a domestic court, even in the bloc's biggest economy, might constrain one of the 19-country euro zone's most powerful institutions.

The ECB delivers its policy decision at 1145 GMT and ECB President Christine Lagarde holds a news conference at 1230 GMT.


MORE MONEY PRINTING

The ECB's first port of call will be to increase the size of its 750 billion euro Pandemic Emergency Purchase Programme, but policymakers are also likely to debate an extension beyond end-2020 as the financial cost of the crisis is certain to impact next year as well.

Economists polled by Reuters expect the bank to top up the scheme by 375 billion euros as they see the economy shrinking by 7.5% this year.

But risks are skewed towards an even bigger increase given that Lagarde recently predicted a GDP drop in the range of 8% to 12%.

The problem is that yields in some indebted countries remain high even as the ECB buys record volumes of debt, putting it on course to exhaust its purchase quota by early autumn.

Italian 10-year bonds still yield nearly 200 basis points more than similar German debt, well above pre-crisis levels, raising doubts about the long-term viability of the country's debt. Italy is among countries worst hit by the pandemic.

"The economic shock is bigger than expected; funding needs will remain very large," Bank of America Merrill Lynch said. "Existing and planned EU backstops, even if fully used, are not enough to help markets absorb such needs."

The ECB could also start buying corporate bonds that have recently lost investment-grade credit ratings.

While such a move would be controversial, the bank has already warned that rating downgrades are coming and the private market simply cannot absorb the new supply of speculative debt, raising the risk of a crash.

A stopgap solution would be to temporarily buy such "fallen angels", giving companies time to regain investment-grade status before the ECB drops them from its purchase scheme.

A big argument against more policy easing on Thursday is the slow progress in the European Union's effort to finalise its 750 billion euro recovery fund proposal.

The ECB could hold out to keep pressure on EU political leaders and to see just what sort of debt the bloc will issue, as it is likely to become the biggest buyer of any new bond.


(Reporting by Balazs Koranyi; Editing by Catherine Evans)