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While the ECB may have disappointed the markets, its asset purchase programme is nothing short of spectacular

The essential

The markets reacted with frustration to December’s meeting of the ECB Governing Council. They had been expecting more.

Nonetheless, the scale of the asset purchase programme is nothing less than spectacular. This can be expected to weigh on long rates and the euro for quite some time to come.

 

Publication

According to virtually all commentators, the ECB “disappointed” the markets when the Governing Council met on 3 December. The communication efforts made by some members of the Council (Draghi and Praet) had suggested that the ECB would further lower the deposit facility rate (the markets expected a reduction to -0.40% but it was actually reduced only to -0.30%) and that the bank would ramp up the pace of its asset purchases (it continues to maintain a pace of €60 bn in monthly asset purchases). Nonetheless, the scale of the ECB’s purchase plan remains impressive.

On 3 December, the ECB decided to extend its asset purchase programme (APP) until March 2017. The programme will continue even though the inflation outlook is not particularly reassuring: a programme without a predetermined end date and an increase in the amounts involved was perhaps too much for the Bundesbank to swallow. As a result, the Eurosystem is expected to purchase €900 bn in securities throughout 2016 and Q1 2017, of which €630 bn will be sovereign bonds. Remember that over the last 12 months, the net supply of sovereign bonds in the eurozone was slightly lower €200 bn. The pace of sovereign securities purchases is greater than 250% of the pace of net bond issues. By comparison, the Fed's QE3 represented only 50% to 60% of net Treasury security issues. Therefore, one could reasonably argue that the ECB’s QE is far more sweeping than the Fed’s programme in regards to its impact on the bond market. Against this backdrop, the pressure on long rates is going to remain high for quite some time.

In addition, the ECB announced that it would reinvest the principal payments on the securities purchased under the PSPP (Public Sector Purchase Programme) as they mature “for as long as necessary”. According to what Mario Draghi said, this decision, coupled with the extension of the PSPP until March 2017, represents a further liquidity injection of €680 bn between now and 2019, i.e. around 6.5% of GDP.

One of the most important aspects of the new measures relates to the extension of the PSPP to marketable debt instruments issued by regional and local governments. This certainly looks like a major concession to Germany because this decision is neutral for virtually all euro zone countries with the exception of Germany, where the marketable debt instruments issued by regional governments represent 30% of all debt instruments issued by the central government. Although several members of the Governing Council welcome the fact that long rates are so low, the Bundesbank obviously does want these rates to be too low. In its most recent Financial Stability Review, the ECB notes in particular that “the current low interest rate environment constitutes the main risk for the European insurance industry”. Implicitly, it can be safely said that the governors do not want to see German long rates fall below a certain threshold. The decision to extend the PSPP to marketable debt instruments issued by regional governments temporarily eases the downward pressure on German long rates but presumably another solution must be found to ensure that the fall in German bond yields is not too great. Mario Draghi also announced that the ECB would revisit or review some of the technical parameters of its programme in the spring of 2016. This is one possibility (reducing the percentage of German bonds in the asset purchase programme in order to increase the percentage of peripheral bonds would be difficult to achieve politically).

It is our view that the various decisions reinforce the interest of buy and hold positions on the peripheral countries and the negative pressure on German rates should slacken somewhat. As an aside, we note that the correlation between German rates on the one hand and Spanish and Italian rates on the other have recovered back to their levels prior to the onset of crisis in the eurozone.

The policy of QE continues to weigh heavily on the euro. While the eurozone is enjoying the highest current account surplus in the world (more than €300 bn over the past four quarters) – even higher than that of China – net fund flows are so negative that for the time being there is no upward pressure on the euro. Many investors from outside the eurozone have already pulled out or are in the process of abandoning the European bond market due to yields that are either too low or negative. The proportion of investors outside the eurozone holding eurozone sovereign bonds continued falling these past few months. There is really no reason for this to end in the short term.

What should we expect from the ECB in 2016? If it continues, the falling price of oil, even if theoretically positive for European growth, will certainly have an impact on inflation projections and could potentially prompt the ECB to further lower its deposit facility rate as a first step. Next, the performance of emergingmarket economies will presumably be a key driver in the decision on whether or not to increase the asset purchase programme.

 

 

 

The pace of sovereign securities purchases is greater than 250% of the pace of net bond issues. By comparison, the Fed's QE3 represented only 50% to 60% of net Treasury security issues

 

 

 

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Cross Asset of January 2016 in English

Cross Asset de Janvier 2016 en Français

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Bastien DRUT, Strategy and Economic Research at Amundi
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While the ECB may have disappointed the markets, its asset purchase programme is nothing short of spectacular
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