ECB may cut support for indebted countries in nudge towards EU loans

[FRANKFURT] The European Central Bank could offer less generous support for indebted governments when it puts together a further stimulus package next month, to push them to apply for European Union loans tied to productive investments, sources told Reuters.

The ECB promised last week to introduce more measures in December to help euro zone countries cope with the second wave of the coronavirus pandemic, including new lockdowns that will curtail economic activity.

The four sources who spoke to Reuters said policymakers were debating whether the ECB should extend its Pandemic Emergency Purchase Programme (PEPP), which gives it unprecedented flexibility in buying bonds from any country in distress, or its regular Asset Purchase Programme (APP), under which purchases should mirror the relative size of each country.

This is because PEPP has driven down borrowing costs for indebted governments such as Spain and Portugal so much that they are shunning EU loans tied to digital and green investments in favour of raising no-strings cash on the bond market.

The composition of the package should be decided at the ECB's Dec 10 policy meeting and the sources said a compromise could be on the cards, with both PEPP and APP being expanded but the former remaining the main instrument.

An ECB spokesman declined to comment.

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The difference between the two programmes is material and the decision will have implications for how much help the ECB might give to the bloc's most indebted countries.

The ECB has significantly overbought Italian and Spanish bonds under PEPP since the first wave of the pandemic in the spring, helping lower their bond yields to pre-pandemic levels - a welcome relief for their governments at a time of stress.

But in doing so, it has made borrowing from the EU's Next Generation fund less attractive.

This form of official credit, unveiled in response to Covid-19, must be spent on green or digital projects and vetted by the EU - making it less palatable to governments than selling bonds when the difference in interest rates is small.

EMERGENCY OVER?

No European government has yet applied for the Next Generation Fund loans, and Spain and Portugal have suggested they are in no rush to do so.

That has irked some ECB rate-setters, who fear governments will not spend the money they have raised productively.

They are advocating that the new stimulus be channelled through the long-established APP, which would restrict funding for different countries according to pre-determined quotas, known as the capital key.

In their view, extending emergency bond purchases beyond next June is not justified as bond markets, which had seized up in the spring for weaker borrowers, have taken the second wave of the pandemic in their stride.

"There's an "E" in PEPP for a reason," one of the sources said.

Other policymakers, however, maintain that the euro zone is still in the acute phase of the pandemic and PEPP should continue, in line with the ECB's own guidance.

The debate has started to spill into the public domain.

Dutch central bank governor Klaas Knot said on Tuesday PEPP was a temporary tool but that Europe was still in an emergency situation and the outlook for inflation worsening.

A day earlier, ECB board member Yves Mersch said PEPP's flexibility should not be extended to other schemes, which must remain bound by the bank's 'red lines'.

The ECB has exhausted nearly half of PEPP's 1.35 trillion euro (S$2.15 trillion) firepower, which it has given itself until next June to deploy.

Italy accounts for just over a quarter of the national government bonds bought under the programme and Spain for 17 per cent - significantly more than their respective quotas in the ECB's paid-in capital.

APP is running at 20 billion euros per month plus a 120 billion euro envelope for this year, which is all but spent.

REUTERS