ECB Insight: Making APP Every Bit as Flexible as PEPP May Be an Unlikely Outcome

7 September 2021

By David Barwick – FRANKFURT (Econostream) – With the European Central Bank’s pandemic emergency purchase programme (PEPP) looking likely to decelerate in 4Q before being allowed to expire at the end of 1Q, barring an extension, speculation concerning the pre-existing asset purchase programme (APP) is mounting.

For example, in a recent research note, NatWest Markets suggested that post-PEPP QE would be ‘likely in the form of a renewed, bolder, APP programme – that should benefit from quasi PEPP-like flexibility’, while SocGen predicts a ‘transition from PEPP to larger and more flexible APP after March 2022’.

Based on monetary authorities’ public comments as well as conversations with officials close to such matters, Econostream would not wish to rule out the inheritance by the APP of the PEPP’s characteristics, but tends to think any such inheritance won’t be complete given obstacles, opposition and the perception within the Eurotower that a flexible ECB can react as and when needed regardless.

That the APP will become larger is, on the other hand, probably a given. An expansion of APP purchases from currently €20 billion per month is a way of mitigating cliff effects and retiring the PEPP, whether next March or later, without forgoing its monetary stimulus, presumably still needed to some degree when the time comes.

The ECB has encouraged such speculation. After promising to reinvest PEPP proceeds in every introductory statement before the conclusion of the strategy review, ECB President Christine Lagarde invariably noted in the very next breath that net buying under the APP would run for as long as necessary.

Understandably, that is about as far as the ECB has wanted to go - the future of the APP is, after all, closely linked to the future of the PEPP, and as recently as July 22, Lagarde continued to deny any discussion of the PEPP’s future at the level of the Governing Council, insisting that ‘anything like that would be totally premature.’

Nonetheless, and it has been reasonably clear for some time that simply transferring relevant features of the PEPP to the APP would be problematic - not just because of the predictable opposition of the more hawkish national central bank governors.

In an interview with Reuters at the end of May, Executive Board member Isabel Schnabel appeared uncomfortable at the idea that the APP would eventually simply assume the features of the PEPP, calling these ‘separate programmes [that] serve different purposes.’

A bone of contention would be that among other things, the flexibility some might wish to transfer wholesale from the PEPP to the APP crucially allows purchases to diverge from the key used to calculate national central banks’ respective share of the ECB’s capital.

To be sure, the rules of the PEPP dictate that ‘the benchmark allocation across jurisdictions will be the Eurosystem capital key of the national central banks’. This appears to be of limited practical relevance, given the ECB also affirms that ‘[a] flexible approach to the composition of purchases under the PEPP is nonetheless essential...’.

The APP clearly lacks this flexibility, based on rules the ECB self-imposed in designing the programme, just as the APP – in contrast to the PEPP – is also prohibited, for example, from breaching sovereign bond issue and issuer limits.

Even so, the APP has provoked German sensibilities, always acute with respect to ECB monetary policy, with court challenges the result. It was precisely the constraints the ECB had embedded in the APP that swayed the outcome in its favour.

Were the relatively unfettered PEPP not anchored in time to the duration of the pandemic crisis phase, its legal invulnerability would be a more questionable proposition.

With that in mind, some Governing Council members would be uncomfortable about changing the APP’s framework so fundamentally. Even if they were in the minority, overriding their principled objections could create the public impression that expediency had trumped proportionality within the Eurotower.

Renewed German complaints would be one reasonably certain outcome.

ECB Vice President Luis de Guindos has played down the importance of the capital key, asserting in a German newspaper interview in late July that while the ECB had ‘deviated from the capital key somewhat at the beginning of the pandemic, which was certainly helpful’, thereafter ‘bond purchases have broadly been in line with the weights of the capital key.’

Governing Council member Gediminas Šimkus has suggested yet more explicitly that PEPP-type flexibility might not be needed.

‘With its inherent flexibility, PEPP has been very successful in reducing fragmentation in the euro area’, he said in an interview with Econostream on July 28. ‘But once the risk of fragmentation is no longer a matter of concern, why do we need to transfer the specific feature of flexibility into other asset purchase programmes that have different purposes?’

‘So, yes, flexibility was an important factor in the PEPP’s success, but this does not automatically mean that we should transfer this characteristic to another asset purchase programme’, he added.

Officials close to the decision-making process who spoke to Econostream on background seemed to play down the debate. One stressed the ECB’s capacity to take any needed steps at any time.

The fact that the strategic review’s outcome did not specifically address the APP does not mean ‘that the APP will never change in the future’, he said. ‘We retain the flexibility to change the design of the tool kit whenever we feel like it. The key thing is that we have those tools in the tool kit.’

Two others dismissed concerns relating to the capital key, with one arguing that ’if we for some reason needed the flexibility, for inflation purposes, I think it would be totally legal, even in the European Court of Justice sense, to have the flexibility in APP.’

‘Because nobody has ever convinced me what the monetary policy argumentation is in using the capital key’ he said. ‘It’s like fairness or political acceptance, or you say that to have the single monetary policy in all countries we need to do it with the capital key. But we have never used the capital key for refinancing operations, for example.’

A third said he ‘wouldn’t be surprised if someone in Germany gets upset’, but pronounced himself nonetheless firmly ‘in favour of moving some of the flexibility of the PEPP to the APP’ to maximise the effectiveness of the single monetary policy. ‘And this is a no-brainer, I think, because if you relax one constraint, you can always do better than with more constraints’, he said.

Still, such a move ‘wouldn’t be easy, for sure’, he conceded. ‘I don’t know whether it is feasible or not. Easy it will not be, I can tell you.’

The issue, he agreed, was the applicability of the capital key. However, he reasoned, those advocating flexibility might argue that the commitment could be retained to eventually wind up respecting the key.

‘Until you reduce and deploy all the portfolios of the APP, the programme is alive, so the potential lifetime of the programme is quite long and you can give yourself some degrees of freedom to permit persistent deviations, even though you keep the commitment that at the very end of the programme, you will end up respecting the capital key’, he said.

The ECB has not yet pronounced itself on the subject of the APP definitively, and may not do so on Thursday, either, beyond observing again that APP asset purchases will continue beyond net PEPP buying. Whether the APP will be endowed with PEPP-style flexibility will be considerably more topical when the future of the PEPP is communicated, which may not be the case until December.