In recent years, and particularly since the start of the pandemic, the pressure on central banks to address climate change has increased. This Update considers the potential implications for financial markets of some of the changes they have made until now, and those that could be around the corner.
- In recent years, and particularly since the start of the pandemic, the pressure on central banks to address climate change has increased. This Update considers the potential implications for financial markets of some of the changes they have made until now, and those that could be around the corner.
- What have major central banks done so far? Their efforts have been largely focused on improving the monitoring and reporting of the macroeconomic risks associated with climate change. But the direction of travel is clearly towards more central banks taking more concrete action. For example, the BoE has recently announced that it will no longer buy bonds issued by highly polluting companies from Q4 2021, while late last year the Risksbank pledged to buy more green bonds as part of its asset purchase programme.
- What could central banks do in the future? Their research has largely focussed on three areas. The first is regulation and macroprudential policy. For example, central banks could promote investment generally in green financial assets by helping to set industry standards in relation to what constitutes “green”. And they could discourage investment by banks in polluting assets by imposing higher capital requirements on them.
- The second is green quantitative easing (QE). Some central banks, like the Riskbank (see above) and the ECB, are already buying green bonds as part of their asset purchase programmes. But most of them are not, and even those that are could do more to “green” their portfolios. For example, the ECB’s purchases of green bonds are currently constrained by the market-neutrality principle, which it could decide to abandon. Central banks could also exclude the most polluting companies from the list of eligible ones.
- The third is green lending operations. Central banks could incentivise commercial banks to lend more money for green investments, by making the interest rate they charge banks conditional on how many green loans they make.
- What might this mean for the markets? All else equal, if central banks were to step up their efforts in tackling climate change through, for example, these three channels, we suspect that it would be positive for green bonds in the medium-to-long term. However, central banks are only one cog in the wheel of green finance. The overall impact on green bonds will also depend, for example, on what happens to fiscal policy as well as on appetite for them from the private sector.
- With that in mind, the performance of green bonds has not been noticeably different from that of corporate bonds in general since the onset of the pandemic. Admittedly, the option-adjusted spread of Bloomberg Barclays’ Green Bond Index rose by less than that of its Aggregate Bond Index during the crisis last spring. But it has fallen back by less in the meantime. In both cases spreads are roughly were they were before the crisis started. (See Chart 1.)
- What’s more, cyclical forces could outweigh structural ones for several years, since central banks aren’t moving very quickly. For example, we wouldn’t be surprised if some sectors of the stock market with relatively poor green credentials outperformed over the next couple of years as economies reopen.
Chart 1: Option-Adjusted Spreads OF Bloomberg Barclays Green Bond & Global Aggregate Indices (%)
Sources: Refinitiv, Capital Economics
Simona Gambarini, Markets Economist, firstname.lastname@example.org