In early 2020, the world was turned upside down by the outbreak of a new viral infection named COVID-19, which the World Health Organisation (WHO) declared a pandemic on 11 March. It has brought with it (at least) three shocks: health, financial and economic, causing one of the deepest crises in peacetime. Governments around the world quickly took unprecedented measures to fight the pandemic, with the top priority being containment of the virus, closely followed by action to stem financial panic and limit the economic fallout, in which they were helped by central banks and supervisors. This article focuses on the initial actions taken by the European Central Bank (ECB) to mitigate the impact of the pandemic.

The ECB significantly expanded its measures with the aim of attaining three main goals, all critical in achieving its primary objective of maintaining price stability: ensuring an overall sufficiently accommodative monetary policy stance, supporting market stabilisation to safeguard the transmission mechanism and providing ample central bank liquidity, especially to maintain credit provision.

To start with, the ECB stepped up its asset purchases: an envelope of € 120 billion was announced to top up planned asset purchases under the Asset Purchase Programme (APP) and a new, temporary purchase programme called the Pandemic Emergency Purchase Programme (PEPP) was launched, with an envelope of € 1 350 billion. These asset purchases, especially under the PEPP, with its large crisis envelope and built-in flexibility, significantly mitigated both common stress and fragmentation pressures in euro area financial markets.

Second, the ECB widened banks’ possibilities to borrow liquidity under its longer-term refinancing operations (LTROs). In that context, the modalities of the third series of targeted longer-term refinancing operations (TLTRO III) were eased, allowing banks to borrow more funds and at lower rates. Moreover, to bridge the period leading up to the very attractive June TLTRO III operation, the ECB announced a new series of LTROs, the so‑called bridge LTROs. To provide an effective backstop for shorter-term liquidity needs after expiry of the bridge LTROs in June, so-called Pandemic Emergency LTROs – PELTROs – were introduced at the end of April. Moreover, to ensure that banks got the full benefit of these more favourable conditions under the ECB’s longer‑term refinancing operations, banks’ collateral requirements were relaxed. Both sets of measures helped to safeguard the bank lending channel. In fact, as a result of the lockdown measures, a large number of businesses faced a sudden and significant drop in their cash flows, forcing them to borrow on a massive scale. Available data until the end of June suggest that euro area banks have been able to meet businesses’ significant liquidity needs in the first few months of the crisis, while credit standards for loans to corporates have also remained relatively easy.

Finally, enhanced US dollar and euro swap and repo lines have helped to mitigate pressures in global funding markets.

Overall, the shortest possible way to summarise how authorities, including the ECB, have managed the financial stress and economic fallout following the COVID-19 pandemic seems to be “so far, so good”. The challenges ahead for monetary policy are manifold, however. One relates to the subdued macroeconomic outlook for which risks are on the downside, while uncertainty about the inflation path is very great. In such a context, both adverse demand and supply factors complicate life for monetary policy, albeit in a different way. Were growth to remain weak because of subdued demand, the resulting low inflation calls for more monetary easing. But with policy rates close to their effective lower bound and non-standard measures already being widely used, delivering the required support to demand is far from easy. If supply factors are behind low growth, inflation will go up and this makes the lower bound problem less pertinent as there is room to raise policy rates. But, in such a configuration, central banks with a clear price stability mandate, like the ECB, have less scope to support economic growth.

At the same time, a normalisation of interest rates will make the debt-overhang challenge caused by COVID‑19 more pressing. Indeed, the current shift towards expansionary fiscal policy has substantially raised the public debt-to-GDP ratio of euro area countries. At the current juncture, these higher public debt levels do not appear threatening, with future interest rates below expected economic growth rates. However, were that configuration to change, questions about debt sustainability could arise, requiring an adequate response by governments. In fact, monetary policy can only deliver on its primary mandate of maintaining price stability if governments can be relied upon to make the necessary fiscal choices to ensure debt is sustainable, especially when interest rates go up. Otherwise, debt sustainability considerations may interfere with the conduct of monetary policy.