By Geoffrey Smith
Investing.com — The European Central Bank is to extend its emergency bond-buying program at its governing council meeting Thursday.
Economists expect that the 1.35 trillion euro ‘envelope’ for the Pandemic Emergency Purchase Program will be expanded by 500 billion euros, and that the central bank will stretch out the horizon for purchases under the program by six months or even 12. Recent practice suggests the ECB will add language opening the door to further extensions, too.
Some people will take that as a positive – especially if they own Eurozone government bonds (basically, Eurozone banks and insurers). Expectations that the ECB’s already massive presence in that market will get even more suffocating has pushed the yields on Portuguese debt below zero for the first time this week, while Spain’s are hovering around zero. Both countries, of course, nearly left the euro zone nine years ago due to crippling debt problems.
However, it is hard to see what is positive about yet another incident in which an emergency measure that was meant to be temporary morphs gradually into another permanent fixture of policy. Especially when the result is to show beyond any reasonable doubt that the natural, risk-free rate of return on capital in Europe is now negative.
The ECB likes to focus on the signals it wants to send. It likes to show that it is not ‘out of ammunition’, that it is capable of influencing outcomes. However, its toolkit is simply not appropriate for the current situation.
“Talk of trying to stimulate an economy when governments are trying to slow economic activity for public health reasons, is not particularly helpful,” Paul Donovan, chief economist with UBS Global Wealth Management, said in a morning podcast. “We’re not facing a credit crisis. Instead, governments have taken money from businesses and consumers through lockdowns and structural changes are putting parts of the economy into a terminal decline.”
Certainly, the ECB still has a role in keeping financial markets orderly – and it’s undeniably true that the PEPP did just that during the spring panic. But what it is doing now is nothing like that, whatever its top management thinks. In an interview with Bloomberg last week, board member Isabel Schnabel described bond markets as “calm”. With all due respect to Frau Schnabel, they are not ‘calm’, they are fundamentally distorted by a central bank that will own nearly half of Eurozone government debt by the time it stops the PEPP.
When it finally gets to that stage, the bank will still doubtless be claiming that it hasn’t violated the principle of monetary financing, even though today’s measures are explicitly tailored to funding a second year of sky-high budget deficits. Heaven forbid that the market should decide the real price of Portuguese or Spanish sovereign risk in today’s circumstances. Or, for that matter, last year’s. Or next year’s. Or the year after that.
The ECB has already killed price discovery for sovereign risk. It is only a small step away from doing the same in private credit risk, flirting with schemes that will punish some activities and reward others under the guise of an initiative to mitigate climate change – as if that can somehow compensate for the growth in emerging market oil demand or the destruction of the Amazon (NASDAQ:) rainforest.
Today’s decisions are all part of the same pattern. Unable to admit the limits of what a central bank can or should do, the ECB is succumbing to mission creep – trying to solve crises it can’t solve, fearful of losing the extraordinary privilege of political independence if it is perceived to be doing too little.
It’s only fair to say that the bank’s officials have the best intentions and have said for years that they can’t be expected to do things that governments should be doing. Even so, the glaring contradictions in its policy are getting ever harder to ignore. It can’t and won’t end well. The only consolation is that the ultimate reckoning can still be pushed out beyond most investors’ relevant time horizons.
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