MNI INTERVIEW: Smaller Facility To Replace ECB's PEPP-Papadia

The European Central Bank is likely to replace its Pandemic Emergency Purchase Programme with a similar, but significantly smaller, bond-buying facility once it expires in March, as it seeks to ensure its monetary policy firepower while the Covid pandemic drags on, the ECB's former director general of market operations Francesco Papadia told MNI.

Creating a smaller successor to the PEPP, which could be deployed if market conditions deteriorate and bond spreads widen, would be more attractive than expanding the ECB's Asset Purchase Programme, Papadia, who served as director general of market operations at the ECB until 2012 and is a former senior Bank of Italy official, said in an interview. Such a facility would offer flexibility at a time of continued Covid uncertainty, even if waves of infection are likely to be less severe than those seen earlier in the pandemic, and also rising inflation, he said.

"I think that they will rather opt for something closer to the PEPP than the APP, but of course much smaller in size and without commitment. I think this would at least address the need the ECB feels to behave with caution and its wish to keep its hands free," he said, referring to the Governing Council's upcoming December meeting.

Such a new facility would supplement the APP's existing EUR20 billion capacity, he said. MNI has previously cited Eurosystem sources saying the ECB was looking at creating a smaller "sleeper" PEPP, to be used only in an emergency. (See MNI SOURCES: Hawks Emboldened As ECB Nears Crunch December)

HIGH BAR

"I think the most likely outcome is that we have another amount, X, and the ECB will spend it as needed. I am thinking of an envelope that they could spend flexibly as needed in response to market conditions, whether those are a tightening in aggregate financial conditions, or changes in specific markets, like Italy, maybe Spain and Portugal etc."

But the bar for deploying the new tool will be high, he said.

"They will have some sensitivity to spreads, but my sense is that spreads would have to move more than aggregate financial conditions for them to react."

The ECB will be keen to ensure that any new ECB programme – like the current PEPP - continues to support Greece, Papadia said, adding that markets might read negative implications into any decision by the ECB not to do so.

"They would not want to rock the boat for Greece, and not just for Greece, because one could interpret what they could do to Greece as an indication of what they could do in the future to Italy, if there was a serious rating downgrade. They will find a way to keep purchasing Greek bonds."