BUND SCARCITY MAKES MAJOR EXTENSION OF ECB’S QE DIFFICULT, WILL BE KEY FACTOR IN ANY DECISION TO TAPER OR EXTEND – SOURCES

 

German bond scarcity a key factor in ECB QE extension debate: sources – Reuters News

 

23-Jun-2017 11:19:08

 

    By Balazs Koranyi

    FRANKFURT, June 23 (Reuters) – The growing scarcity of

German government bonds makes any major extension of the

European Central Bank’s asset buying scheme difficult and this

will be a key consideration when policymakers decide whether to

extend the buys, three sources told Reuters.

    German sovereign debt available for purchase by the ECB will

be exhausted, at the latest, by the middle of next year, so a

meaningful extension would require a redesign of the programme,

a contentious issue since growth and inflation are both slowly

moving in the right direction, sources with direct knowledge of

the discussion said.

    The 2.3 trillion euro bond buying programme, designed to

revive inflation, is set to run until the end this year but even

if policymakers agree this fall to wind it down, an orderly

reduction known as tapering would carry it well into next year.

    The problem is that the ECB’s self-imposed rules mean it can

only buy up to one-third of each country’s debt and given

Germany’s relatively low debt level, it is only months away from

reaching this limit.

    "I just don’t see where we could find enough German bonds to

keep this programme running beyond mid-2018, at best," a source,

who asked not to be named said. "If you want to extend, you have

to reconsider the parameters and that’s a difficult sell when

everything is going in the right direction."

    "This will be a major factor in our decision on the future

of the programme," the source added.

    While the ECB has argued that the programme has built-in

flexibility, the comments suggest that such room for manoeuvre

is now clearly limited and will constrain the Governing Council.

    The ECB has not put a deadline on extending or winding down

the scheme but a decision is likely either on either Sept 7 or

Oct 26, giving markets several months to prepare.

    The ECB declined to comment.

    According to bank analyst estimates, the ECB could run up

against the limits for sourcing bonds in Germany anytime between

the end of this year and mid-2018.

    Jefferies for instance calculates that the ECB’s

asset-purchases scheme has another seven months to run in

Germany compared with 16 months in France and 25 in Italy.

    The ECB could substitute German debt for bonds of

supranational institutions or municipalities, but these markets

lack the type of liquidity for the necessary volumes, the

sources said.

    Already running out of longer-dated German bonds, the ECB is

now buying shorter and shorter papers, booking losses as yields

are deep in negative territory. Indeed, German bonds bought in

May had a maturity of just four years — the shortest since the

scheme was launched in March 2015.

 

    JUSTIFIED?

    The key contention is whether the slow rise of inflation

would justify a major redesign, which could open legal debates

and generate fierce opposition from more conservative countries,

including Germany, the bloc’s biggest economy and home to the

ECB.

    Having flirted with deflation two years ago, consumer prices

are rising again but will not hit the ECB’s target of just under

2 percent for years to come. Tapering in such an environment

could be seen as giving up on the target, some critics argue.

    "The reasons why we launched this programme are no longer

there," a Governing Council member said. "We fought off the

threat of deflation and the risk of contagion between member

states after the debt crisis."

    Indeed, ECB board member Benoit Coeure recently argued that

inflation is less dependent on the ECB’s monetary policy

measures, which suggests that inflation is becoming self

sustaining, a key criteria for the removal of ECB stimulus.

    Another problem is that a major redesign would meet fierce

opposition from Germany and its allies, a potentially costly

battle.

    "Why not hold off on that battle until you have an emergency

or urgent situation?" a third source said. "With inflation

pointing in the right direction and growth moving higher, this

is not a necessary fight."

    The ECB has already looked at lifting its self-imposed

limits but concluded that altering many of them, like the 33

percent limit on each country’s debt, could open the door to

legal challenges.

    "I suspect and fear that the technical constraints have

become a policy constraint as well," said Pictet Wealth

Management senior economist Frederik Ducrozet.

    "I think it will transpire in their decision. It is clear,"

said Ducrozet, who estimates that the ECB already bought less

German paper in April and May than the country’s shareholding in

the bank would warrant.

 

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ECB Balance sheet vs inflation    http://reut.rs/2s2Lbie

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(Reporting by Balazs Koranyi; Additional reporting by Dhara

Ranasinghe in London; Editing by Toby Chopra)

((Balazs.Koranyi@thomsonreuters.com; +49 69 7565 1244; Reuters

Messaging: balazs.koranyi.thomsonreuters.com@reuters.net))

 

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