- By purchasing corporate bonds, central banks increase the amount of money in the system and drive up the prices of said bonds. As bond prices go up, the yields fall – thus it becomes cheaper for large corporates to finance ventures by issuing bonds.
- The central banks can also purchase, and up the prices, of bonds linked to lending at commercial banks. This, in turn, encourages commercial banks to increase their lending and create more such, secured bonds – and, as an affect, the interest rate commercial banks offer may fall.
- All in all, it becomes cheaper to borrow – for companies as well as private individuals – which increases demand. This means prices can go up and inflation rise.
Just like the Riksbank, the ECB has an inflation target of two percent – with the aim of creating price stability. To increase inflation to the desired level, after the financial crisis in 2008, the ECB lowered the key interest rate all the way to negative levels. The move did not succeed, however, which is why the ECB Council, as a next step, decided to launch a purchasing programme – see fact box below.
Part of the ECB's purchasing programme targeted corporate bonds. This, the so-called Corporate Sector Purchase Programme (CSPP), started in 2016. In January this year, the total value of the assets which had been purchased under the CSPP was approximately €344 billion.
When the net purchases within the CSPP ended in July 2022, the ECB President, Isabel Schnabel, announced that the central bank would start a gradual ‘greenification’ of its holdings. But what could such a shift mean in practice?
“As the bonds that the ECB owns mature, some of the money invested in environmentally questionable businesses will be withdrawn from the market. Another part of the capital will, however, be reinvested in green bonds. So even if the investment total decreases, the amount placed in green bonds may even increase”, says Jussi Hiljanen, chief strategist at SEB.
“Later, when the ECB stops reinvesting the money from maturing bonds completely, the central bank has expressed that it wants to start selling off environmentally questionable holdings prematurely, and shift to sustainable alternatives. All in all, the ECB strategy will start deviating from that of the Fed. The explanation lies in the fact that, in addition to the inflation target, the ECB has a secondary mandate to support the union’s political policy.”
When the U.S. Fed chair Jerome Powell commented on the differences between the two central banks, he underlined that the Fed does not have the regulatory power to follow in ECB’s footsteps, before adding: “We are not, and will not be, a climate policymaker”. So, what effects does Jussi Hiljanen believe that the ECB’s new strategy may have?
“The knowledge that the ECB is interested in buying green bonds strengthens the will of large corporates to issue them. In addition, investors' interest in buying green bonds will grow.”
A fully slow-moving freight train – the ECB is the locomotive
There is no doubt that the ECB now intends to bet everything on green. At the same time, little is known regarding the specifics of how this move will be conducted.
“That fact that the ECB is not only shifting to green when bonds mature, but also plans to start selling off non-green bonds prematurely, is a move towards a more aggressive sustainability strategy. Yet, the ECB has not disclosed which parameters it will evaluate companies on. We do know the criteria are linked to current emissions, the potential to reduce emissions and to sustainability reporting – but not exactly how”, says Thomas Thygesen, Head of Strategy for Investment Banking at SEB.
“The timetable hasn’t been communicated, either – that is, how quickly the ECB intends to start selling off the holdings it no longer wishes to have.”
Why doesn't the ECB reveal what its criteria for evaluation?
“Probably because this entails a risk that companies would start optimizing against the criteria, rather than pursuing the sustainability issues that are the most significant.”
Despite all the question marks, Thygesen sees the ECB's shift in strategy for corporate bonds as a significant move.
“It is a very strong signal and a very powerful tool that the ECB is employing. The message, quite simply, is that your loans will become more expensive if you do not take sustainability into account. This affects all players in the market. One of the main arguments for issuing green bonds has previously been the somewhat vague 'it’s what the investors call for'. Now the ECB has added power to those words.”
What can we expect this to result in?
“It will have major effects, but these are not possible to quantify in terms of, for example, how many more billions that will be invested sustainably, or how many more wind turbines that will be built. Everything is intertwined in complex manner and could be viewed as slow-moving freight train, where the ECB is the locomotive”, Thygesen concludes.