ECB’s Lane Calls Countering Spreads a ‘Basic Task’ of Central Banks

1 May, 2020

By David Barwick – FRANKFURT (EconoStream) – It is a “basic task” of the European Central Bank to ward off the destabilising threat that spreads can pose, according to ECB Executive Board member Philip Lane on Friday.

In a blog post on the ECB’s website, Lane, who is also Chief Economist of the ECB, said that compared to the policy meeting of 12 March, the ECB on Thursday saw a “substantially deteriorated” picture with respect to the impact of the pandemic’s economic fallout as well as to the tail risks of the crisis.

The relevant risk-free yield curve, which Lane called the “cornerstone” of financial conditions, is at record lows due to global forces and the ECB’s suite of measures, he noted. The potential for sovereign debt to soar as governments borrow to counter the pandemic’s economic impact could subject the curve to upward pressure, prompting central banks to exercise a key function by loosening the monetary reins, he said.

Market stabilisation via liquidity backstops and asset purchases is a further “crucial” role of central banks, he said, and under Monetary Union, this takes on added significance because “a crisis environment can give rise to self-fulfilling flight-to-safety dynamics and illiquidity in individual sovereign bond markets.”

“Such non-fundamental volatility in spreads impairs the smooth transmission of monetary policy across countries and it is a basic task for the central bank to counter such destabilising forces,” he added.

With that remark, the ECB has now completely walked back ECB President Christine Lagarde’s comment on March 12 that the central bank was “not here to close spreads.” In conjunction with Lane’s suggestion that the PEPP is well suited to the situation - with its total size depressing the risk-free curve and the flexibility of its design helping to stabilize financial markets – the ECB may be laying the groundwork for an expansion of its asset purchases.

“… the successful implementation of the PEPP is critical in delivering the favourable financial conditions that are necessary to support the economy, in view of the severe risks both to the monetary policy transmission mechanism and the outlook for the euro area posed by the pandemic,” Lane said.

Looking forward, the ECB’s policy stance would have to guard “against the escalation of tail risks associated with procyclical financial amplification mechanisms,” he asserted.

He repeated the ECB’s assertion that its determination to safeguard price stability under the current circumstances could lead it to expand yet further its programme of asset purchases or to modify the composition of its purchases.