ECB QE: Bazooka or fudge?

Expected programme

At Thursday’s ECB Governing Council meeting we expect the ECB to announce a QE programme of at least €500bn (5% of euro area GDP), although a programme size of up to €700bn is possible at a push. The programme looks likely to consist predominantly of purchases of euro area member state sovereign bonds, which are likely to account for around 75% of the total assets bought. Bonds of non-financial corporations are also likely to feature in the overall package, with a possible share of 20%. And we assume that a small amount of supranational bonds (EIB in particular) will also be included.

Duration and pace

The ECB is also likely to specify an end date for the programme and/or a monthly purchase pace in order to define the programme trajectory. We expect that purchases would be set to end in December 2016, implying a monthly purchase pace of approximately €20bn to €30bn. However, a shorter timeframe for the programme with commensurately greater purchase volumes each month (e.g. €50bn per month over the coming twelve months) is also perfectly feasible.

Sovereign bond purchases

Within the main category of sovereign debt, we believe that purchases will be apportioned in relation to member states’ “capital key” share, which is proportional to GDP and population size. German-led concerns about potential losses from sovereign bond holdings being mutualised via the ECB’s balance sheet are likely to be addressed through two main mechanisms:

  • National central banks will ultimately bear the risk of possible sovereign default on QE purchases;
  • Non-investment grade sovereigns (notably Greece) will only be included if they adhere to policy conditions under a continuous EU/IMF financial assistance programme or stand-by arrangement.

Corporate and supranational bonds

We expect the ECB to retain corporate bonds (and the associated risks) on its consolidated balance sheet, with purchases possibly being subject to broadly similar credit quality criteria as those applied in the ECB’s covered bond purchases. We expect supranational agency bonds also to be treated as a collective asset on the ECB’s books.

Maturity of bond purchases

Both the ECB and the NCBs have an incentive to steer clear of buying negative-yielding bonds, which is likely to result in comparatively long average maturities for purchases of core countries’ bonds and EIB bonds. Lower-rated sovereigns and corporate bonds could be bought at somewhat shorter average maturities. There may well be a requirement that purchases per country and per maturity bucket remain below 25% of the respective market size. Nevertheless, the expected purchases imply very high demand for certain core government bonds (especially Bunds) relative to supply over the coming two years.

Will it do the trick?

We have long argued that a full-blown ECB QE programme was the only meaningful policy response left to the ECB. The expected size of at least €500bn may be sufficient to hit the ECB’s €3trn balance sheet intention. But that €3trn aim was established in September, and the inflation and growth outlook has deteriorated markedly subsequently. So, while we believe that tomorrow’s programme will help, it is unlikely to be sufficient to bring inflation back to target.

In particular, the numerous political constraints that the ECB has faced in its design make this a likely second-best programme. For instance, focussing its firepower on the periphery, where rates are highest, would have had a more meaningful impact on the average euro area interest rate. As it is, the likely relative skew of purchases towards the core, where interest rates are already exceptionally low, means that the impact via the ‘interest rate’ channel will be less forceful than it might otherwise have been. At the same time, the impact via the ‘expectations’ channel will be limited by the continued perception that the ECB is doing the minimum necessary, and then only reluctantly. There is certainly no sense that the ECB is really prepared to do “whatever it takes” to get inflation back to target and we doubt that Draghi will be able to surprise markets with a larger programme size than is expected, which would have increased the chances of markets, consumers and businesses having renewed faith in the ECB’s commitment to its inflation target. Although 5Y/5Y inflation expectations have recovered a little they seem unlikely to rise much further in the short term on the back of ECB action. And while a further depreciation of the euro should help lift inflation via higher import prices and support net exports this impact is also likely to be modest.

So, tomorrow’s announcement (finally) of proper QE will mark a step forward for the ECB. But it comes months (and arguably years) too late, and in a size and format that is not going to change very meaningfully the direction of the euro area economy. The noisy battles over QE seen in the run up to this first salvo may well prove nothing in comparison to what will come if and when Draghi concludes that this first round needs augmenting. This is an argument that could run and run for years, all the while undermining the ECB’s credibility in its ability to hit its inflation target

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