Finally, QE from the ECB

The ECB’s QE will not be a panacea to cure all ills, but it is a necessary prerequisite to prevent the euro area sliding into a deflationary spiral.

At Thursday’s press conference, Mario Draghi has announced the ECB’s QE programme, labelled Expanded Asset Purchase Programme (EAPP), which, in several aspects, surpasses the expectations fostered by the drip-drip of leaks in the days running up to the meeting.

The main features are:

  • The ECB will buy bonds issued by euro area central governments, agencies and European institutions in the secondary market.
  • The programme will encompass the existing programme for purchasing ABSs and covered bonds. Combined monthly purchases will amount to €60bn.
  • Purchases will continued being made until at least September 2016 and, in any event, until the course of inflation has re-adjusted towards 2%.
  • Purchases of sovereign bonds will include maturities between two and thirty years.
  • Non-investment-grade bonds (Greece, Portugal, Cyprus) are not excluded, but some additional eligibility criteria will be applied.
  • 20% of the purchases will be subject to risk-sharing. Potential losses on the remaining 80% will be borne by national central banks (NCBs).
  • Purchases will be subject to issue restrictions in order to limit market distortion (33% of an issuer; 25% of an issue).
  • The ECB will be pari passu (not senior to other creditors).

Announcements beat in many regards what had been expected

  • Big amounts: The expectation for €50bn a month was slightly beaten. Purchases of covered bonds and ABSs (€9bn monthly in the last three months) do have to be subtracted from the €60bn monthly purchases announced.
    Total purchases should amount to €1,140bn by September 2016, so the ECB should be able to boost its balance sheet towards €3,000bn by Spring 2016.
  • Long term: The programme is practically open-ended. Expectations had been for one or two years – it will last at least 19 months.
  • Long maturity: 2Y to 30Y covers the whole spectrum.
  • Non-investment-grade paper is not excluded. Greece is currently apparently reaching the 33% limit. However, in July, some of the bonds held in the SMP programme will mature. As such, the opportunity to buy Greek sovereign bonds once more will present itself again.
  • Risk-sharing: Potential losses will not be concentrated on NCBs as recent press reports had suggested – 20% of the purchases will be subject to mutual risk-sharing.
    Mario Draghi insisted several times on the fact that some limits on mutualisation of ECB actions are not new. Monetary-policy action has fiscal implications. Things are more complicated in a multi- country framework.
  • According to Mario Draghi, the EAPP was approved and adopted by a large majority and, apparently, with much less acrimony than rumours circulating in recent days had suggested.

Market reaction

Market reaction has been very positive. The pattern of rising interest rates and euro appreciation observed in recent days shifted into reverse during the press conference: 10-year Bund yields are back to 0.45%; periphery sovereign bond yields have dropped (10Y BTP: 1.57%; 10Y Bonos: 1.42%); the $/€ is at 1.14. However, the ultimate measure of success of the programme will be long-term inflation expectations. The 5Y5Y swap break-even has continued to climb since last Friday: it stands at 1.7% today, a distinct bounce from the 1.48% recorded on 14 January.

The ECB’s QE programme will not be a silver bullet. Much will hinge on how expectations evolve, with the programme’s benefits likely to be twofold:

  1. it will help to anchor inflation expectations, thereby relaxing real monetary conditions;
  2. it will decouple ECB monetary-policy action from that of other major central banks, thereby exerting downward pressure on the euro’s value.

Financial markets are also likely to find support in the measures announced today.
However, monetary policy cannot resolve the structural weaknesses besetting most euro countries (low potential growth due to demographic developments and low productivity). As such, the ECB’s QE programme needs to be accompanied by structural-adjustment policies in order to brighten the economic outlook for the euro area.

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