How does the ECB’s asset purchase programme work?
22 January 2016 (updated on 25 November 2022)
What is the purpose of the asset purchase programme?
In normal economic times the ECB steers broader financial conditions and, ultimately, macroeconomic developments and inflation by setting the short-term key interest rates. However, as a result of the global financial crisis in 2008 and changes in the way our economy works, key interest rates came close to their effective lower bound – the point at which lowering them further would have little to no effect. The ECB therefore turned to other measures to address the risk that inflation could be too low for too long, and to bring inflation back to the Governing Council’s target of 2% over the medium term. The asset purchase programme (APP) is one of the tools the ECB can use to achieve this. Net purchases under the APP ended in July 2022; principal payments from maturing securities purchased under it are still being reinvested in full.
How does the APP work?
The ECB and national central banks bought a range of assets under the APP, including government bonds, securities issued by European supranational institutions, corporate bonds, asset-backed securities and covered bonds. Such purchases influence broader financial conditions and, eventually, economic growth and inflation, through three main channels:
When the ECB buys private sector assets, such as asset-backed securities and covered bonds, which are linked to loans that banks grant to households and businesses in the real economy, the increased demand drives up their prices. This encourages banks to make more loans, which they can then use to create and sell more asset-backed securities or covered bonds. The increased supply of loans tends to lower bank lending rates for businesses and households, improving broader financing conditions.
The ECB has purchased private and public sector assets from investors such as pension funds, banks and households. These investors may choose to take the funds they receive in exchange for assets sold to the ECB and invest them in other assets. By increasing demand for assets more broadly, the portfolio rebalancing mechanism pushes prices up and yields down, even for assets that are not directly targeted by the APP. This results in reduced costs (the effective market interest rate) for businesses seeking financing on the capital markets. At the same time, lower yields on securities encourage banks to lend to businesses or households. More bank lending to the real economy tends to lower the costs of borrowing for households and businesses. If, on the other hand, investors use the extra funds to buy higher-yielding assets outside the euro area, this may also lower the euro exchange rate, which tends to put upward pressure on inflation.
Both the direct pass-through and the portfolio rebalancing channels improve broader financial conditions for businesses and households in the euro area. By lowering funding costs, asset purchases can stimulate investment and consumption. In times when inflation is too low, more dynamic demand from both businesses and consumers eventually contributes to returning inflation to 2% over the medium term.
In periods when inflation is too low for too long, asset purchases also send a signal that the central bank will keep key interest rates low for an extended period of time. This reduces volatility and uncertainty in the market regarding future interest rate developments, which facilitates investment decisions taken by businesses and households. Interest rates charged on long-term loans will remain lower, as banks anticipate a longer period of low interest rates.
Update: This explainer was last updated on 25 November 2022 to reflect the end of net asset purchases.