The deficit bonds: what will the ECB to support growth in Europe


The deficit from austerity

The volume of assets purchased by the European Central Bank (ECB) in the framework launched a year and a half ago the programme of quantitative easing (QE) has exceeded the symbolic mark of €1 trillion, revealed on 5 September, the ECB. The regulator buys mainly government bonds of European countries: the largest share in the acquired assets are bonds Germany (€238 billion), followed by paper France (€189 billion) and Italy (€164 billion). Among the purchased securities are bonds and corporate bonds, but their share is small — about €20 billion Total program amounts to €1.7 trillion, it is designed to March 2017.

Thursday, 8 September, the ECB is expected to extend its asset purchase programme by six months until September 2017. But there is a problem: soon it may happen that the Central Bank would have nothing to buy.

According to the current parameters QE, the ECB’s monthly buying of securities amounting to €80 billion (the bar has been raised in March 2016 with €60 billion per month). While the ECB has established a number of restrictions on purchase of bonds: their yields should not be lower than the Central Bank rate on overnight deposits (now minus 0.4%) in the portfolio, the ECB may not be more than 33% of all marketable bonds of the issuing country to purchase the paper necessary in proportion to countries in GDP (the principle of the capital key). These conditions increasingly difficult to meet when the bond yields of many European countries has long gone negative.

This is a particular problem with German papers. More than 60% of all German bonds now trade with yields below minus 0.4%, which puts these papers beyond the criteria of the ECB, stated in the review of Credit Suisse, dated September 2, (have). According to estimates by Credit Suisse, the German paper, suitable under the criteria of QE will be exhausted before the end of 2016, the same applies to bonds Finland.

Now the market is about €620 billion of bonds of European countries that meet the criteria of the ECB. By March 2017, the ECB will take away from the paper market of approximately €567 billion, predicts Credit Suisse.

To similar conclusions come from UBS, SEB and Credit Agricole. “If the ECB will not be able to purchase German bonds, he will have to change the terms of the buyout,” wrote in the middle of August in his report of Credit Agricole. The Bank noted that to replace German bonds will be nothing too big, their share in QE.

If the QE program will be extended to September 2017, by which time (subject to existing restrictions), the ECB will be available to purchase only bonds of Belgium and Italy, follows from the review of Credit Suisse.

What to do?

Investment banks agree that to solve the ECB will have to change the existing restrictions on the purchase of bonds, and the sooner the better. According to Reinhard Cluse of UBS, changes can be made at the next meeting of the ECB governing Council on 8 September. Analysts at Danske Bank believe that this week the ECB is unlikely to announce the increase of the limits, but it can create a working group to resolve the problem.

The regulator has three main paths follows from the related Credit Suisse, Credit Agricole, ABN AMRO and other investment banks. The ECB can afford to buy bonds with a yield below minus 0.4%, to increase its maximum share in the total debt of the Issuer is higher than 33% or to derogate from the principle capital key, which currently limits the purchase of securities of countries like Italy or Ireland.

More likely the Central Bank will untie the hands of the abolition of the 33% limit on purchases of securities of one Issuer. Credit Suisse has calculated that in the case of raising the limit to 50% for QE assets will increase by €665 billion the Most probable is a scenario in which already at the next ECB meeting would increase the limit from 33 to 50%, said a strategist at Mizuho International Antoine Beauvais.

But the market effect of this step will be controversial — according to estimates by Credit Suisse, this could further reduce bond yields, and ultimately can create problems with their availability. In addition, if the ECB will have the opportunity to buy up to 50% of the country’s debt, it can be regarded as the actual financing of budget deficits.

If the ECB starts to buy bonds with a yield lower than the current rates on deposits, that would allow for QE securities advanced by €390 billion. However, according to analysts at Credit Agricole Louis Arro, in the case of extending QE until September 2017 removal of restrictions on the profitability of the acquired securities will be insufficient “to drown out concerns about the lack of bonds of Germany, Finland, the Netherlands and Spain.

As stated by a senior economist at the Dutch Rabobank’s Elwin de Groot, decisions about changing the rules of QE is expected in December, the ECB needs time to develop a plan of action. According to Groote, the most likely option, in which both will be removed the limitation on the profitability and increased the limit on securities of one Issuer.

Finally, the abolition of the principle capital key will allow the ECB to buy further bonds for €620 billion In this case the ECB can buy more bonds from countries with larger debt, in particular Italy, one of the largest debtors among the advanced economies (after the US and Japan). Such a scenario could also raise concerns about monetary financing of the budget deficit — the President of the Bundesbank and member of the ECB governing Council Jens Weidmann in August said that the refusal of key capital leads to a blurring of the boundaries between monetary and fiscal policy”.

But Groot of Rabobank believes that abandoning the principle of capital key would be too politically sensitive decision, especially after Brexit. The removal of this restriction which will allow you to buy more Italian debt, may be perceived as helping the weaker economies in the Eurozone to the detriment of everyone else, it can become the object of criticism by eurosceptics and play into the hands of their political ambitions, including in Germany.

The ECB, there is another alternative: an introduction to the QE program new classes and types of assets. Speech can go as about investing in stocks and exchange traded funds and acquisition of bonds with more or less long maturity, it is now (now ECB acquires bonds with maturities from two to thirty years).

The more the ECB buys the securities under QE, the harder it becomes to investors to purchase such highly reliable assets like German government bonds, notes Beauvais from Mizuho International. In the result of QE, the yield of such securities is further reduced and they become less attractive to investors — they have to go into other, more risky assets.

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