To a randomly drawn North American yuppy, Covid could be the name of some unruly five-year old in a Montessori classroom. And like that hyper-active, petulant child, Covid-19 has been a disruptor, bringing long-standing problems into, in the case of the European Union, stark relief.
Covid has jostled the applecart, and demands attention. It has stressed, rented and is tearing at the economic fabric. Responding, the European Central Bank (ECB) announced last week its into-the-breach Pandemic Emergency Purchase Program (PEPP), empowering the ECB to buy up to an additional EUR750 bln in EU sovereign debt obligations between now and year-end.
This prospective liquidity transfusion would correspond to an additional quantitative easing measure approximating 6% of the European Union’s (EU) gross domestic product (GDP). This, according to the Wall Street Journal, comes on top of the already EUR2.6 trln in “previous rounds of QE”. Moreover, the ECB will be breaking with hallowed rules to calm the markets and to crisis manage. The Common Currency Area’s central bank will no longer abide by its “capital key” guide – that is, limiting its purchases of a specific EU member’s sovereign debt. The new “stretch” aims and goals for the ECB are the result instead of a stark reality the WSJ summarizes nicely:
“German, Dutch and other Northern European politicians have resisted such attempts to deepen the eurozone into a currency – and fiscal-union. But they have also resisted attempts to push economic and fiscal laggards out of the bloc, have failed to demand genuine economic and fiscal reforms…”
Bear in mind that Italy, the third largest economy in the euro-zone, is now the problem too big to be allowed to worsen, or to be wished away. Covid’s economic punch has been staggering for the EU, and may put in question one of it’s more substantial, but possibly less resilient members. The ECB and European policymakers are now reacting on the fly.
The table below highlights the credit standing of the EU’s three largest members. Germany is the largest economy by a significant margin, but both Germany and France are roughly comparable in terms of the credit risk they present. The third largest economy, Italy, is less so. On the table, one can see major agency ratings, and also the MMD default risk metric – the Solvency Institutional Resilience Estimate (SIRE) – a logit regression model which represents a sovereign’s estimated credit standing.
The higher the SIRE score indicates a stronger, more robust credit standing. Plainly, the Italian sovereign’s standing is much weaker. Italy is in many ways a successful economy and society, but the Covid-19 crisis will exacerbate vulnerabilities, increasing event risk for Italy and the euro-zone. Hence, the bold moves from the ECB in response, measures policy makers in Frankfurt would rather avoid.