ECB looking for the exit, any exit?

Robert Sierra - 02 November 2016

A couple of weeks ago, “unnamed sources” claimed the ECB was thinking of winding down its bond purchases, or tapering, triggering an immediate jump in yields across bond markets. This would be done, it was claimed, in gradual steps of about €10bn a month, broadly in line with the actions of the Fed in 2014. Strategists and the financial market in general were torn between suspicion that there is no smoke without fire and a realistic assessment that the ECB may not be able to taper given its failure to lift Eurozone inflation.
Talk of tapering seems premature when underlying annual price increases are currently at 0.8% and overall inflation is expected to rise only to 1.6% in two years’ time. After the rumour spread, the ECB went out of its way to reassure markets that QE tapering is not up for discussion. The head of the Bank’s media noted that the governing council had not discussed the topic, as Draghi mentioned during the press conference and at his testimony to the European Parliament.
The minutes of the Governing Council meeting in September, published a couple of days after the Bloomberg story, noted that “there was still no clear upward trend visible in measures of underlying inflation, which remained low”. This is a crucial statement since the ECB’s forward guidance on QE is that it “will continue until a sustained adjustment in the path of inflation consistent with its inflation aim”. And there is no sign that this objective has yet been met. Perhaps the “rumours” were true and they are simply intended to placate (the Germans?) and to signal that after the next move, perhaps coming as early as December, asset purchases will eventually be wound down.
We suggest that the more immediate concern for the Governing Council to address is bond scarcity, especially if QE is extended. The most recent data release for September shows that government bonds continue to make up the bulk of what the ECB buys, accounting for over eighty per cent of the purchases (Figure 1) while corporate bond acquisitions constitute 12% of the total or €9.9bn. Importantly, given some self-imposed restrictions, the ECB is having to buy bonds with a longer maturity increasing the average maturity of its PSPP purchases. Germany, for instance, now holds bonds with an average maturity of close to 8 years from 7 years at the beginning at the start of the programme. Moreover, it is the public debt of Germany, France, Italy and Spain which continues to benefit from the programme, with the ECB buying above and beyond that which is justified by the capital key allocation (Figure 2).
On current estimates, there are about €130bn Bunds outstanding that the ECB could buy. Extending the bond buying programme would entail loosening the following restrictions which currently constrain the central bank: 1) that bond yields must be at or above the deposit facility rate of -0.4%, 2) that the geographical distribution of purchases be in line with the capital key (although as we just suggested this is already being broken) and 3) that purchases don’t exceed 33% for any one bond or issuer.
We suspect that a premature tapering announcement at the current juncture runs the risk of triggering a Eurozone version of the 2013 US ‘taper tantrum’. Managing expectations will be key to avoid market disruptions. To that end, the ECB will likely prolong QE at the current pace whilst tweaking existing rules and verbally preparing the markets for an eventual exit but not until late next year.

Figure 1

Data Source: ECB

Figure 2

Source: AllianzGI

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