On 10 March, the ECB Governing Council raised its pace of monthly purchases from €60bn to €80bn and extended it to corporate bonds. It said it did so
The technical limits of the ECB’s QE
The ECB’s public sector purchase programme (PSPP), which makes up most of its QE programme, is subject to a large number of technical restrictions:
Meanwhile, these purchases are prorated to national central banks’ weightings in the ECB’s capital, and only 20% of risks are shared by euro zone states.
QE’s technical restrictions will quickly become an issue. Germany’s large share in the ECB’s capital (about 27%), its shrinking public debt and the fact that the German yield curve is below -0.40% until maturities of 5 years suggests that the PSPP will not be feasible for Germany until about March 2017. This estimate is obviously extremely sensitive to market fluctuations as a large number of German bonds have residual maturities of about 3, 4, 5, 6 years.
Press coverage has also highlighted that the Eurosystem could soon reach the issuer share limit for Ireland and Portugal.
The current solution when the issuer and issue share limits are reached is for the national central bank concerned to instead buy bonds issued by supranational institutions. Raising the issuer and issue share limits from 33% to 50% has expanded the stock of PSPP-eligible “supra” securities to about
The ECB’s QE adjustments will be essential if QE is extended beyond March 2017.
What adjustments should be made to QE?
Several options are possible for extending ECB’s QE after March 2017:
What would the impact be on the bond market?
When a major central bank conducts a QE policy, the slightest hint of a possible adjustment is likely to have a signifi cant impact on bond yields. The most famous example is the infamous “temper tantrum” of May 2013. Ben Bernanke, then chairman of the FOMC, said that the Fed could reduce its QE3 securities purchases, sending US 10-year yields up from about 1.60% to 3% within four months. Emerging currencies were hit hard during this episode. Sooner or later, Euro bond investors will face a similar episode, but it is highly unlikely to be of the same extent.
The “taper tantrum” caused the markets to price in a slowdown in securities purchases and imminent hikes in the Fed Funds rate. FOMC members then had to talk fast to detach interest rate expectations from QE policy expectations. Not until December 2015 did the Fed fi rst raise its Fed Funds rate and, for the time being, the markets are pricing in just one more rate hike in 2016.
Let’s turn back to the ECB’s QE extension beyond March 2017. Even assuming that the ECB decided to buy fewer sovereign bonds (shifting from sovereign bonds towards corporate bonds or equities) or fewer German bonds each month (if sovereign bond purchases were no longer prorated to countries’ capital in the ECB, but based on another metric), the ECB’s monetary policy would remain extremely accommodative with the modified QE and there would be no reason for a change in interest-rate expectations that would send long German yields up sharply in a taper tantrum-type episode.
When will a decision be made on whether to extend?
It was on 22 January 2015 that the ECB announced plans to start a QE programme. Initially, the programme was to last only until September 2016. On 3 December 2015 it postponed the scheduled end date to March 2017. So the announcement of an extension was made about nine months before the “scheduled end”. Based on the same scheme, the ECB is therefore likely to decide right about now whether to extend the QE beyond 2017… That said, the extension decided in December 2015 comes amidst some urgency to undertake easing measures. The decision to extend QE after March 2017 can reasonably be expected to be made in September 2016, which means that the QE’s ECB will once again be a market theme as early as this summer.
Availability of German paper
When a major central bank
The ECB’s QE will once
The ECB’s QE is making euro zone states solvent again