FRANKFURT (Reuters) – European Central Bank President Christine Lagarde brokered a difficult compromise this week to secure backing for a new pandemic-fighting package of measures, but her battle to convince sceptics among her colleagues and investors has only just begun.
The ECB unveiled plans to buy an additional half trillion euros worth of bonds and give banks even larger subsidies for keeping credit flowing, in a bid to support the euro zone economy through the expected end of the coronavirus outbreak.
The package, aimed at keeping borrowing costs low for governments, households and firms, takes the ECB closer than ever to outright targeting of specific levels in bond yields and spreads, without saying as much openly.
But conversations with five sources on or close to the ECB’s Governing Council suggest that the Dec. 9-10 meeting was tense and that disagreements on the new round of bond purchases had started even before it.
The ECB had kicked off discussions last week with an envelope of 750 billion euros for bond purchases but cut it down to 500 billion euros before the meeting after receiving pushback.
Still, chief economist Philip Lane’s scaled-down proposal came close to running aground at the meeting as policymakers disagreed on the economic outlook, the size of the bond buys and the terms of the subsidised loans to banks.
Lagarde intervened to orchestrate an agreement on the policy tools, offering concessions to dissenters rather than sidelining them as her predecessor Mario Draghi did on occasion, the sources said.
In one case, Lagarde helped win dissenters over by emphasising that the 500 billion euros ($608 billion) envelope would not need to be spent in full if financing conditions remained easy.
That reassured governors who wanted smaller debt purchases as bond yields are already languishing at record lows, spreads are tight and government paper is hard to find in some smaller countries.
Lagarde also said the envelope could be increased. But that would require a new decision by the Governing Council, making the hurdle implicitly higher.
“It’s no longer an envelope but a ceiling, a maximum amount,” one of the sources said.
Austrian central bank governor Robert Holzmann also said on Friday that he did not expect the ECB to use the entire amount.
Policymakers were also at odds on the size of the Targeted Longer-Term Refinancing Operations (TLTRO), an increasingly controversial facility whereby banks are paid to borrow from the ECB as long as they don’t shrink their loan books.
Policy hawks were opposing Philip Lane’s initial suggestion to increase the maximum amount banks will be entitled to borrow from 50% to 60% of their eligible loans, but Lagarde managed to clinch a compromise half way at 55%, the sources said.
In the end, the package was backed by a large majority.
A spokesman for the central bank declined to comment for this story.
Speaking on Friday, Lithuanian central bank governor Vitas Vasiliauskas said he had reservations about providing too much extra stimulus but was happy with the agreement reched on Thursday.
THE END OF THE BEGINNING?
Winning agreement on Thursday’s package may, however, prove the first of many challenges for the ECB president, who started in the job just over a year ago.
First, some sceptics of the deal maintained their reservations, saying in private that this was an implicit form of “yield-curve control” and needed to end as soon as the pandemic was over.
“Keeping spreads stable is bad economics,” one of the sources said, arguing that market prices must be allowed to reflect economic fundamentals.
Even TLTRO, until recently one of the ECB’s most consensual tools, is now becoming a target of criticism as it effectively subsidises banks and eases pressure on them to get back into shape or merge.
Second, by making bond purchases conditional on the level of borrowing costs rather than committing to them whatever happens, the ECB may be inviting markets to test its resolve.
This kind of tentative language had been a source of frequent criticism of the euro zone’s central bank during the early part of the 2010-12 debt crisis but was swept aside by Mario Draghi soon after becoming president with his pledge to do “whatever it takes” to save the euro.
“Now that the market knows the commitment to PEPP is a soft one, expect it to challenge the ECB’s resoluteness as data surprises to the upside and as hawks become more vocal,” Marco Brancolini, an economist at Nomura said.
($1 = 0.8227 euros)
(Reporting by Francesco Canepa, Balazs Koranyi and Frank Siebelt; Editing by Hugh Lawson)