Christine Lagarde Is Third-Time Lucky

(Bloomberg Opinion) -- It’s third time lucky for the European Central Bank.

On Wednesday night, the ECB announced a 750 billion euro ($820 billion) quantitative easing program to help the euro zone economy deal with the Covid-19 shock. The central bank had been slow off the blocks in dealing with the crisis, and then stumbled at the first obstacle with a terrible mistake by President Christine Lagarde. The ECB is finally now up to speed — and investors are taking notice.

The plan, which was launched during an emergency meeting, has several attractive attributes on top of its expanded size. It cuts across sovereign and corporate debt, and also includes commercial paper. It will extend to Greece, which had been excluded from quantitative easing so far. It will be flexible, meaning that the ECB will be able to allocate the money where it is most needed on a temporary basis.

Most importantly, it points to further action in the future, if necessary. “Extraordinary times require extraordinary action. There are no limits to our commitment to the euro,” Lagarde tweeted.

The decision sent bond yields plummeting across the region. Italy’s bond yields are down nearly 80 basis points to around 1.65%. The interest rate on Greek debt is falling even more, by 170 basis points, to below 2%. But really everyone has benefited — from Spain to Portugal, and even to France and Germany.

This is a further sign of how this is a pan-European crisis that requires a pan-European solution.

However, there are still problems with the ECB announcement. The central bank is insisting in keeping its self-imposed limits. For example, its purchases have to track the central bank’s capital key, which means a large chunk of its purchases must be German bunds — which investors consider extremely safe. The ECB also cannot buy more than 33% of an issuer’s outstanding securities, including from sovereigns.

The ECB has said it is prepared to review its limits in the future, but it’s keeping them in place for now. In theory, this could pose problems in the execution of the program, as the central bank cannot be as flexible in its purchases as it might otherwise be.

However, as the size of the purchases expand, their allocation becomes less relevant. Even though the ECB must above all buy bunds, it can now purchase a lot more Italian, Spanish or French bonds. Also, as governments borrow more to fund a fiscal stimulus to keep their economies going at a time of unprecedented stress, the amount of sovereign bonds will inevitably increase. The ECB will have many more bonds to buy before worrying that it hold too much of a given government’s debt.

The central bank is, in a sense, making good after its earlier mistakes. The ECB was the slowest of all major central banks in issuing an initial statement that showed it was taking the crisis seriously. It launched a first, sizeable package of measures last week, but botched it when Lagarde said that it wasn’t the central bank’s job to close spreads — causing panic in the financial markets. The ECB appears to have learnt the lesson now.

Of course, central bank actions will not, on their own, solve this economic crisis. Governments must ensure that enough money flows to families and businesses, at a time when many economies are already in lockdown, and others could be soon. The Eurogroup of finance ministers announced some initial steps on Monday, but the size of the total fiscal commitments is still inadequate for the challenge facing the euro zone. All of this while a lasting cure to the health crisis remains to be found: Lockdowns and other measures can only help to slow down the spread of the virus. The ultimate solution must come from scientists, who are seeking effective treatments and a possible vaccine.

However, the ECB is finally doing what it can to ensure a health crisis does not generate a new sovereign debt crisis. For a moment, there was fear that the ECB was no longer serious about its commitment to do “whatever it takes” to keep the euro together. For the time being, investors can be reassured.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Ferdinando Giugliano writes columns on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.

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