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ECB bond reinvestments could be shock absorber as QE decelerates

ECB bond reinvestments could be shock absorber as QE decelerates

4 min. 16.09.2017 From our online archive
An average of €15 billion a month of assets held under quantitative easing will mature next year according to euro-area central bank officials.

(Bloomberg) As the European Central Bank prepares to slow its bond-buying program, policy makers are considering softening the blow by highlighting a related measure -- the reinvestment of maturing debt.

An average of €15 billion a month of assets held under quantitative easing will mature next year, according to euro-area central bank officials who said the figure was presented at the last Governing Council meeting. While the plan to reinvest that cash has long been a part of policy, the ECB is concerned that investors are under-appreciating its impact, three of the people said. A spokesman for the central bank declined to comment.

Emphasising the flow of spending needed to maintain its stock of holdings gives the ECB a way to play down a key risk burdening policy makers -- that any decision to start reducing net asset purchases might tighten markets. The dilemma is that more than €2 trillion of QE so far has provided robust economic growth, spurring calls in some quarters to end bond buying, but it hasn’t yet led to sustained inflation.

"I do constantly hear people asking whether it is time to start tapering," ECB Executive Board member Peter Praet said in an interview with De Tijd published on Saturday. "But underlying inflation remains too low. We have to be patient and persevere with our policy, a substantial stimulus is still necessary. Everyone agrees that we have to make sure that the reduction of the stimulus takes place in an orderly manner, without any excessive shocks."

Be Careful

The last time the Governing Council adjusted QE, it extended purchases by nine months and slowed the monthly pace to €60 billion from €80 billion, citing an improved economic outlook. That schedule comes to an end in December, and President Mario Draghi has said the bulk of the decisions for 2018 will be taken in October. Praet said the ECB will have to "be very careful about the words we use."

While the ECB projects inflation of 1.2% next year and 1.5% in 2019, compared with a goal of just under 2%, most economists surveyed by Bloomberg predict purchases will soon start to be phased out.

Yet should the monthly pace be slowed -- for example to €30 billion -- the ECB could try to mitigate any negative impact by noting that total spending including reinvestments would average about €45 billion.

"Sounds like we could be in store for a ‘super-stealthy taper’," said Richard Barwell, an economist at BNP Paribas Asset Management in London. "The second stage of the taper could be downplayed as a mere adjustment just like the first, even though going from 60 to 30 billion a month in January opens up the possibility of a hard stop in July, and now the true deceleration in net bond buying could be camouflaged by focusing attention on gross purchases."

Inevitable Decision

It’s not yet decided whether the ECB will disclose the specific value of reinvestments when it lays out next year’s plans, the people said, asking not to be named because the Governing Council’s deliberations are confidential. Details such as whether replacement purchases must match the nationality and duration of the maturing bonds also have yet to be agreed on, they said.

The ECB has two more policy meetings scheduled before the end of the year, on October 26 and December 14. Executive Board member Sabine Lautenschläger said this week that it’s time to take a decision "now" on scaling back bond purchases at the beginning of next year. Slovenian Governor Bostjan Jazbec said a decision to reduce buying will "inevitably" come but was postponed because economic developments don’t yet support it.

Draghi, who has previously urged patience and prudence in communicating the withdrawal of stimulus, is scheduled to speak in Frankfurt on September 21 and Dublin the next day.

Silver Lining

The reinvestments also offer potential room for flexibility on the type of purchases, which could help the ECB overcome any shortages.

Over half a trillion euros of debt issued by the top four beneficiary nations in the QE program -- Germany, France, Italy and Spain -- is due for redemption next year, with roughly €125 billion owned by the ECB, according to Bloomberg calculations.

Holdings will total almost €2.3 trillion by the end of 2017, and economists have warned that some asset classes such as German debt will soon become scarce. The ECB has already been deviating from the so-called capital key, which links the volumes of public-sector purchases by national central banks to the relative sizes of the currency bloc’s economies. That has allowed it to buy more debt from countries such as Italy and France, where availability is greater.

One consequence of the higher purchases is that they help depress yields in those nations, reducing the financing burden on governments. According to BNP’s Barwell, the pending discussions on reinvestments mean that bonus could continue.

"Once you set the precedent that reinvestments can be redeployed around the euro zone then you have the possibility that the composition of the bond portfolio could continue to shift toward Italy even when QE is done," he said. "That would be a silver lining for Italy on an otherwise dark cloud of premature exit."