ECB’s Schnabel: To Keep Financing Conditions Favourable as Long as Needed
28 January 2021
By David Barwick – FRANKFURT (Econostream) – The European Central Bank intends to keep financing conditions favourable as long as needed, ECB Executive Board member Isabel Schnabel said Thursday.
In a speech at the LSE conference on ‘Financial Cycles, Risk, Macroeconomic Causes and Consequences’, the text of which the ECB made available, Schnabel said that so-called cliff effects resulting from the removal of policy support instituted during the crisis could lead to financial instability.
Not all policy support is under the ECB’s control, she reminded. ‘What we can do, however, is preserve favourable financing conditions for as long as necessary to reinforce and amplify the fiscal support and to ensure that private investment is not crowded out,’ she said.
Such a commitment was the outcome of last week’s Governing Council meeting, she said. It implies ‘insulating the bank lending channel from adverse developments, to the extent possible’, which is why the ECB recalibrated its targeted longer-term refinancing operations (TLTROs), she said.
‘Preserving favourable financing conditions also means protecting relevant borrowing rates in financial markets from a tightening that would be inconsistent with countering the downward impact of the pandemic on the projected path of inflation’, which was the thinking behind the recalibration of the pandemic emergency purchase programme (PEPP), she said.
The ECB is ‘equally’ open to not using all funds allocated to the PEPP if favourable financing conditions do not require their exhaustion, and to recalibrating the envelope if necessary, she reiterated.
Schnabel affirmed that the PEPP’s extended horizon exerts a stabilising effect and ‘significantly mitigates the risks of a sudden repricing and of self-fulfilling price spirals that threatened to impair the transmission of our policy in March last year.’
This in turn can potentiate the ECB’s asset purchases, because ‘[i]t allows us to calibrate our purchases flexibly according to market conditions, consistent with our commitment to preserve favourable financing conditions’, she said.
‘In summary, by focusing on duration and preservation, we are sending a clear signal to markets that the current broad-based policy mix will continue to provide the necessary support to bridge the time until the economy can stand on its own feet once again’, she said.
Schnabel observed that because ‘corporate health has become more dependent on the domestic sovereign’s fiscal support, the withdrawal of government support could lead to cliff effects, giving rise to financial instabilities.’
In addition to corporate defaults, a consequence could be an increase in non-performing loans and a tightening of financing conditions, she said. ‘This, in turn, could cause problems in the banking sector, deepening the recession and further eroding the sovereign’s revenues, while requiring even more guarantees and higher public debt, putting pressure on the sovereign’s credit standing’, she said.
Thus, whereas what she called the ‘sovereign-bank-corporate nexus’ was a ‘crucial’ source of stability during the pandemic, it could lead to a ‘vicious circle, giving rise to destabilising feedback loops’, she said.
However, she said, policy support ‘minimise[s] the realisation of contingent liabilities in the future, and thus limit[s] the scarring effects of the pandemic on the economy, creating a virtuous circle.’
This, she noted, is in contrast to the ‘sovereign-bank nexus’ that has haunted the Eurozone in the recent past. ‘[T]he current nexus, if managed properly, can be an engine for a faster recovery, which also supports the ECB’s price stability mandate’, she said.
Still, Schnabel urged governments to ‘be mindful of cliff effects that might set off a vicious circle of corporate defaults, tighter bank lending conditions and growing sovereign vulnerabilities.’
‘We therefore continue to call on governments to extend targeted government support for as long as needed and to use public funds responsibly, with a clear focus on raising productivity and long-term growth potential’, she said.