Anti-fragmentation
The ECB puts some PEPP in its step
My work on European monetary union is part of a collaboration with Steffen Murau; I am responsible for what is expressed here.
Sentiment on eurozone integrity is often measured by the interest rate paid by the treasuries of Italy and Spain relative to that paid by Germany’s. These bond spreads have lately been elevated, and last month, the European Central Bank announced the creation of a new facility, the “transmission protection instrument,” to address them.
The TPI has not yet been activated. But as Nikou Asgari of the Financial Times reports, the ECB has already begun using existing channels to try to bring spreads down. In this post, I show that pivot is not only in PEPP, as Asgari reports, but also PSPP. So far, the ECB has shifted about 20 billion euros from German and Dutch to Spanish and Italian debt.
The ECB’s sovereign debt reinvestments have shifted
Like other central banks, the ECB responded to the emergence of COVID-19 by embarking on a program of large-scale asset purchases. Its main vehicle has been the pandemic emergency purchase program, or PEPP. When the central bank stopped net purchases in March 2022, the fund had reached about 1.7 trillion euros, almost entirely in public-sector securities.
Since then, the total balance has been held steady. But to do so, the ECB has had to reinvest funds from maturing securities. As Asgari noted, they have taken the opportunity to reduce holdings of German debt and increase holdings of Spanish and Italian debt. This graph shows net flows of public-sector securities through the PEPP—inflows from purchases, less outflows as securities are repaid. Flows are accumulated in two-month windows, which is how the ECB provides the data:
The admittedly garish color scheme gives a legible breakdown of the eleven top issuers. (“Supranationals” refers to EFSF/ESM bonds.) The shift to reinvestment after March 2022 is clearly visible, but only beginning in June 2022 do German and Dutch bonds move into the negative side, with the proceeds put into Italian and Spanish debt.
If the PEPP is being used this way, we should also check out the ECB’s other big collection of securities, the public sector purchase program, part of the ECB’s previous round of bond-buying. The PSPP dates from 2014, and as with PEPP, purchases have recently stopped, leaving it at a level of 2.6 trillion euros. This graph shows monthly flows through the PSPP for the pandemic period only:
The picture is more varied here, but the pivot between May and July 2022 is exactly the same as above. In particular flows of German debt went quickly into reverse during that time.
Preview of TPI?
These data cast a new light on Christine Lagarde’s June press conference. TPI is a special facility: it must still have been in the works in June, and was not unveiled until the following meeting. But already in June, the ECB president was asked repeatedly about fragmentation, and said three separate times that PEPP reinvestments could be used to reduce bond spreads. Since about the time of that press conference, the ECB has been doing just that, within the scope of existing facilities, allowing German and Dutch bonds to run off in both the PEPP and the PSPP, and reinvesting the proceeds overwhelmingly in Spanish and Italian bonds. This graph shows the flows from both facilities over the two months:
Not too shabby.