30 June 2015

ECB's Praet: The APP impact on the economy and bond markets

Intervention by Peter Praet, Member of the Executive Board of the ECB, at the annual dinner of the ECB’s Bond Market Contact Group, Frankfurt am Main, 30 June 2015

In remarks today I would like to briefly assess the current economic situation before addressing a few salient points about the ECB’s expanded Asset Purchase Programme (APP).

So far the economic recovery in the euro area remains on track and, importantly, we are seeing evidence that it is starting to broaden. Real GDP rose by 0.4% q-o-q in the first quarter of 2015, with domestic demand continuing to be the main driver behind output growth. While growth has been mainly supported by private consumption in recent quarters, there are encouraging signs that private investment is picking up as well. The latest survey results, though showing some signs of stabilisation, remain consistent with continued growth in the second quarter at around the same rate as in the first quarter.

A number of factors are underpinning the recovery in activity. First, the earlier fall in oil prices is contributing to higher real disposable incomes and corporate profitability. Second, the accommodative monetary policy stance, including the expanded APP, has led to improvements in financial conditions and credit supply conditions. Third, euro area activity is expected to be increasingly supported by the past depreciation of the euro and the gradual strengthening of external demand. These three factors mean that, while remaining on the downside, the risks surrounding the economic outlook have become more balanced.

It is nonetheless clear that monetary policy and external factors cannot alone be the basis for a lasting recovery. I see two risks in particular to a stronger, structural recovery. The first is that pessimism among firms about future growth prospects continues to weigh on investment. [...] The second is the persistence of a debt overhang in parts of the euro area which acts as a major drag on firm and household spending. In both cases structural reforms come to the fore, as lifting expectations of trend growth is key to reduce uncertainty about the outlook and deleverage private sector balance sheets.

This context of a firming recovery underpins our expectation for inflation to steadily return towards our objective. [...]We still expect inflation to remain low in the months ahead before accelerating later this year, in part on account of base effects associated with the fall in oil prices in late 2014. Thereafter, inflation is expected to gradually converge towards levels closer to but still below 2%.

That outlook is of course contingent on the full implementation of our APP. As of 26 June 2015 the ECB had purchased EUR 297.1 bn under the entire APP,[...] Accordingly, the ECB’s balance sheet has expanded by EUR 527 bn to EUR 2,539.5 bn since end-September 2014, mainly due to the asset purchases and the four TLTROs.

For the PSPP we have been able to achieve all operational targets (i.e. announced quantities and parameters of the asset allocation) and purchases have by and large not been disruptive to market functioning. Since mid-April, however, volatility has risen markedly, reversing the initial downward impact of the PSPP on sovereign bond yields. GDP-weighted euro area sovereign yields are now roughly half a percentage point higher than the level reached on the day of the PSPP announcement. But we need to be patient in assessing the significance of these developments. Such a reversal of the downward trend in sovereign yields following a QE announcement is common to other jurisdictions which undertook similar policies in the past.

Our purchases of private assets have also proceeded relatively well. The CBPP3 has had a strong downward impact on covered bonds spreads, which reached the tightest levels in the last five years at the start of June this year. And though from mid-April yields have increased in line with other fixed income assets, they have done so to a lesser extent. As a result, the attractiveness of covered bonds has declined compared to government bonds, contributing to an increase in the amount of offers available for CBPP3 purchases. [...]

In terms of ABS, while the announcement and start of ABSPP led to a general compression of spreads across all euro area countries, since mid-April the spreads of more stressed jurisdictions have widened and moved above the levels prevailing at the start of the programme. [...]

What ultimately matters from a monetary policy perspective, however, is not how well we achieve our operational targets but how much our interventions are reflected in a reduced cost of borrowing for firms and households. Here we see a positive impact from the APP on both the bank and market finance. The cost of market-based debt has followed a downward trend since end-2011 and stabilised at historically low levels in February-April 2015, before rising again somewhat in May (+16 bp) and June (+20 bp). Market-based financing flows have nevertheless continued to increase in recent months, implying that the lower cost of market-based finance has had an important “first order” monetary policy effect.

On the bank side, the APP seems to have been effective in further reducing wholesale funding costs, as portfolio rebalance effects have led to a compression of, for example, bank bond yields. Consequently, while the cost of borrowing from banks for households and firms has been declining since mid-2014, the pace of the decline has increased in recent months. In April, the composite bank lending rates for households for house purchase and for non-financial corporations stood at 2.25 and 2.30%, respectively 61 and 49 bps below the values observed in June 2014. These developments reflect both the effect of the APP and of the previous measures taken in the summer of last year.

While it may be too early to see a clear upward effect in terms of quantities, there are several signs that the APP is also contributing to an easing of credit constraints in the euro area. [...]

It must be noted, however, that banks’ expectations that the APP will negatively impact profitability do not seem to be aligned with either market evaluations or our own internal appraisals. [...]The overall effect on bank capital is found to be positive, as capital gains on securities held, lower funding costs, improved credit quality and higher intermediation volumes outweigh the negative impact of the flattening of the term structure on net interest income.

In sum, it is fair to conclude that, thus far, the APP has been producing its intended aim of easing of monetary and financial conditions, including in the context of heightened volatility since mid-April. [...]We note however that the expected policy rate path implied by markets has shifted up and steepened noticeably in a context of market re-pricing. Still, at present we judge that the recent strong fluctuations in financial markets have not materially altered money and credit dynamics, but close monitoring and continuous assessment are warranted from a monetary policy perspective.

[...]

We are not only willing to act, but capable of doing so. The recent ruling by the European Court of Justice, while finding that OMTs fall within the scope of the ECB’s mandate of maintaining price stability, also stated clearly that the ECB must be allowed “broad discretion” when preparing and implementing its monetary policy.

In short, we have the tools available, if needed, to ensure the appropriate monetary policy stance for the whole euro area, and to react to specific impairments in the transmission mechanism – if, as was the case in the past, such impairments were judged to undermine the recovery and slow the process by which we anticipate inflation to return to levels closer to 2%.

Full speech

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