When will the ECB run out of bonds?

Posted on September 8, 2016

The headquarters of the European Central Bank©AFP

The headquarters of the European Central Bank

From the moment the European Central Bank first announced plans to revive the eurozone economy with a mass bond-buying programme, financial markets have been bracing for trouble. First the focus was illiquidity and mispricing — now it is scarcity.

The mechanics of the ECB’s quantitative easing project means banks and investors believe the central bank cannot keep on buying €80bn of bonds a month as planned — or extend quantitative easing — unless it relaxes rules about what it can buy.

    With the eurozone’s recovery proving relatively lacklustre, the ECB has vowed to continue QE at least until March and many economists expect it will be forced to prolong the programme beyond that date.

    But credit analysts at banks including Citi, HSBC, Bank of America Merrill Lynch, BNP Paribas and JPMorgan and investors such as Pimco all say the €1.6tn programme is fast approaching a wall, perhaps as early as this year. The trouble is that no one outside the ECB knows how close the wall is.

    Unlike the Bank of England, the ECB has chosen not to provide the market with precise data on the bonds it owns. It has opted to group bonds issued by government-backed agencies together with sovereign bonds and to avoid publishing details on the amount of a particular bond it owns — forcing economists and analysts to estimate.

    Their starting point is the market value of outstanding government, agency, supra and sub-sovereign debt in the eurozone — currently €7.5tn, according to figures from Dutch bank Rabobank.

    However, the volume of bonds the ECB can buy is far smaller because its rules forbid it from holding more than a third of any specific bond issue or more than a third of any one country’s debt. Those rules also oblige the bank to buy bonds in line with the size of member states’ economies, meaning it must buy far more German bonds than other government paper.

    The central bank also limits purchases to bonds with maturities between two and 30 years and with a yield above the eurozone’s deposit rate of minus 0.4 per cent — a restriction that has caused an increasing squeeze, as the rally in bond markets pushes the yields on eurozone debt into negative territory.

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    Tradeweb, which uses data from its own trading platform, calculates that there is €1.5tn of eurozone government debt with maturities between two and 30 years trade at yields under the minus 0.4 per cent limit — making such bonds ineligible for ECB purchase.

    However, this figure does not account for the bonds the ECB already owns, meaning the actual stock of ineligible debt is probably larger.

    Citi believes the squeeze is so severe that the ECB will run out of German paper to buy in November, although BofA thinks the programme can run unaltered until the end of the year.

    “The nature of QE data released by the ECB means approximations and assumptions have to be made when estimating how close each central bank is to its own limits,” said Ruairi Hourihane, rates strategist at BofA. “There is quite a wide range of estimates as to when exactly the Bundesbank will hit this limit.”

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