ECB: Carbon pricing significantly more effective than green QE

A central bank policy of buying only green bonds would have a small impact on global temperatures, research by the European Central Bank has concluded.

For more than a decade, central banks have carried out asset purchases as part of quantitative easing programmes designed to stimulate economic growth. Recently, they have faced growing calls to integrate environmental factors within the process.

Studies have shown that asset-buying conducted by the ECB and the Bank of England are significantly biased in favour of carbon-intensive issuers, despite a stated objective of market neutrality.

A newly published ECB paper suggests that one version of so-called green QE would have minimal impact on climate mitigation, leading only to a 0.04C global temperature reduction by 2100. This is based on a hypothetical scenario where a global central bank reallocates its entire investment portfolio to green bonds.

The size of the portfolio is calibrated in line with those held by central banks within advanced economies.

By comparison, the introduction of a $50 per tonne carbon price – which falls at the low end of many climate policy proposals – would result in an emissions reduction four times larger than the maximum which could be achieved by exclusively buying green bonds, estimated at around 0.17°C.

The study did not take into account the financial performance of a green versus a dirty portfolio or other green investment strategies, such as excluding bonds from carbon-intensive sectors or buying sustainability-linked bonds to provide funding for green transition activities.

It comes as central banks increasingly pursue green investment strategies, with the ECB having announced a green tilt to around €30 billion worth of investments due to take place this year. The Monetary Authority of Singapore is set to apply a similar tilt in favour of lower-carbon issuers and has committed to stop investing in coal and oil sands

A carbon price would impose a cost to company emissions through a tax or market. The latter, known as an emissions trading system (ETS), requires firms to buy and sell carbon “allowances” or “credits”, and is widely seen as the most promising market-based mechanism to lower global emissions.

But current carbon prices – $53.74 and $6.89 per tonne on average under the European and Chinese ETS in 2021, respectively – are much lower than needed to influence the business decisions of big emitters. A Goldman Sachs analysis estimates that a price of more than $100 per tonne is needed to reduce global emissions by 50 percent with current technologies.

Aviva’s chief responsible investment officer Steve Waygood has described a robust carbon price as the “most important data point currently missing” from efforts to decarbonise the global economy.

Speaking at a 2021 OECD roundtable, Waygood said: “What we need from a valuation perspective is clarity around the forward cost curve for carbon pricing. It is only when we have a carbon price which reflects the external costs of climate change that markets will work. At the moment, the biggest market failure is that the cost of capital does not reflect the full cost of carbon – and that can only be corrected through government policy.”