Euro-area officials are looking at activating the region’s bailout fund to help contain the impact of the coronavirus, a crucial step toward triggering the European Central Bank’s most powerful bond-buying powers.
With government bond yields spiraling, officials are giving serious consideration to a plan that would see the European Stability Mechanism set up multiple credit lines for euro-area nations, according to three people familiar with the discussions.
The move would help alleviate pressure on countries with strained public finances such as Italy and Spain. Italian bonds reversed losses after the report, with the yield on 10-year securities trading down 19 basis points at 3:17 p.m. in London.
In addition to tapping into 410 billion euros ($450 billion) of ESM money to bring down borrowing costs, such agreements could also pave the way for the ECB to buy vast amounts of sovereign bonds through its Outright Monetary Transactions program if the stability of the euro area is in jeopardy.
Discussions are accelerating as policy makers witness the rout in euro-area bonds, one of the officials said. All three cautioned that no decisions have been taken, and asked not to be named due to the sensitivity of the issue. Spokesmen for the ECB and the ESM declined to comment.
‘Most Appropriate Way’
“There may well be push back from wealthier euro area states on this plan, but for what it is worth this is probably the most appropriate way to introduce common euro sovereign issuance without generating bad publicity domestically,” said Peter Chatwell, head of European rates strategy at Mizuho International Plc.
The spread between Italian and German bonds “is now much tighter on the day and, if this plan was to be implemented, should allow all euro credit spreads to tighten materially from here,” he said.
Originally built to bail out nations at the peak of the European debt crisis, the ESM has been mostly idle since Greece exited its aid program in 2018. The ECB’s program, meanwhile, grew out the 2012 pledge by then-President Mario Draghi to do “whatever it takes” to save the euro-area.
Draghi’s promise and the existence of OMT steered the euro zone out of its debt crisis, although the program itself has never actually been used.
While sovereign bond yields across the euro area are nowhere near their crisis-era highs, the prospect of a deep recession caused by the coronavirus pandemic has led to a sharp spike in borrowing costs over recent days.
In theory, lending from the ESM comes with conditions attached, though one of the officials said that in this case the fund won’t demand any belt tightening as the focus would be on tackling the contagion and its impact on the economy. What’s more, establishing credit lines with several countries at once would remove the stigma that typically goes with financial aid.
All the same, deploying these tools would need unanimous approval by euro-area member states and officials insisted that it would still be difficult. Even limited conditionality could be a red flag for Italy but without it countries like Germany, Finland and the Netherlands might not be prepared to sign off, the officials said.
EU leaders discussed the possibility of deploying the ESM during a teleconference on Tuesday and German Chancellor Angela Merkel cautioned that it would be difficult to use the fund without attaching conditions. Dutch Premier Mark Rutte was even more skeptical, saying that any changes in the way the ESM operates would struggle to get approval from the Dutch parliament, according to an EU official with knowledge of the discussion. Still, neither of them shot down the idea, the official said.
In a further indication that leaders are prepared to forgo budget restrictions while they tackle the virus, the European Commission is expected in the coming days to propose that governments to invoke a general crisis clause allowing them to spend as much as they need to. The suggestion may be presented to leaders ahead of a videoconference next week, one of the officials said.
The option of using the ESM’s credit lines is less complicated and faster than other ideas being floated, such as the joint issuance of debt, in the form of so-called “coronabonds.” Among other obstacles, that plan would require the backing of the German Bundestag and there are doubts as to whether Merkel could secure that given her domestic weakness as she prepares to step down.
The plans are being drafted as Europe is bracing for an unprecedented economic shock. ECB President Christine Lagarde told EU leaders over a videoconference on Tuesday that euro area output will shrink by 2% this year if a virus-induced lockdown in the continent lasts for one month, and by 5% if it stays for three months, two people familiar with the matter said.
The ECB president also mentioned the prospect of a 2% to 5% recession in a call between euro-area finance ministers on Monday, a separate official said. One of the officials said Lagarde mentioned analysts’ expectations of a contraction by up to 10% this year if the lockdown drags for longer, though such estimates aren’t based on ECB’s own calculations.
An ECB spokesman declined to comment.
(Updates with ECB recession projections in last two paragraphs)
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