How Many Irish bonds can QE buy?

The ECB’s expanded  QE is due to start in March and a figure of €12bn is often reported in terms of the amount of Irish sovereign debt that the Central bank can buy. The case is not that clear-cut , however,  and the limit may be only €9bn from June.

Bonds purchased in any EA  country  under QE are subject to a number of restrictions. The first limits the share  of the total each country can buy. In Ireland that means about 1.7% of  the €60bn per month  QE target, which includes private and  EU supranationals as well as government debt. The second limits central bank buying to 25% of any issue. A third puts a  33% ceiling  on the amount of   any issuer’s debt that can be held . The latter only makes sense relative to the 25% limit if existing central bank holdings are included .

Indeed,the ECB does already own some sovereign debt, purchased under the Securities Market Program (SMP) , which stands at €144bn having fallen from over €200bn (via bonds maturing). We do not know the  current breakdown of that holding by country but the ECB did publish that data as at end-2012. At  that time €14bn of Irish government debt  had been purchased, 6.5% of the then total, which implies about €9bn today, assuming redemptions were broadly proportional over the past two years.

The Irish Central Bank also owns government debt stemming from the Anglo Promissory note. Part of that was repaid  in 2012 via the issuance of €3.5bn  of the 5.4% 2025 bond. The Bank announced it had sold a portion of that in 2013 but presumably still owns around €3bn of that issue. In addition, the Central bank received €25bn in long term bonds as part of the Promissory note deal in 2013   and again has sold a small amount, leaving €24.5bn.

Another QE stipulation is that  only bonds with a maturity  between 2 and 30 years are eligible, which in Ireland’s  case gives a current figure of €86bn. That implies  €8.5bn of central bank holdings are within that range ( including €5.5bn of the Prom note bonds) which alongside the €9bn SMP figure gives €17.5bn or 20% of the total at issue. The issue limit therefore leaves only 13% open to further purchase, which is just under €11bn

Finance Minister Noonan stated that the Central bank had ‘ample room ‘ to purchase Irish debt. However, the situation changes in mid-year as  €3bn of the Prom note bonds redeem in June 2045 (i.e. would then fall within the 30 year limit), so  from then on the CB’s eligible  holdings rise to €20.5bn or 23% of the total, implying less than €9bn could be added.

Some SMP holdings will mature over the next 18 months and the Central bank will sell some of its Prom note bonds, so giving some room for additional QE, The NTMA will also issue new debt (perhaps another €11bn this year) which  will qualify as long as it is over 2 years so raising the remaining limit for the Central bank rule. Perhaps not quite as ‘ample’ then as some think, in the short term and with more moving parts.

 

ECB to buy Government debt but limited risk sharing

The ECB today decided to buy sovereign debt, a decision  which, although widely anticipated, had the immediate effect of weakening the euro further on the FX markets and  giving a further fillip to government bonds, which were already at record yield lows in many cases. Equities too rallied although it remains to be seen  when the dust settles how much of the ECB policy change  was already priced in to markets.

Mario Draghi gave two reasons for the move. First, inflation has been weaker than expected and inflation expectations have fallen further, which could in turn have a negative impact on wage and price developments particularly given the level of spare capacity in the euro zone.Second, the existing monetary policy measures in place have not had much of an impact and in that context it was announced that the interest rate on the long term loans available to banks (the TLTRO) will be reduced from 0.15% to 0.05% , an implicit admission that the take-up has been disappointing.

The ECB is also currently buying private sector debt (covered bonds and asset backed securities) in the secondary market  but again the impact has been limited, with only €35bn purchased to date. Consequently the ECB decided to significantly expand the programme to include public sector debt (Government and European Institutions), although some in the council were still of a mind to wait and see how inflation develops in the coming months. The expanded QE programme will now amount to €60bn per month, starting in March and continuing until September 2016,with the prospect of extending it further until there is a ‘a sustained adjustment in the path of inflation which is consistent with our aim of achieving inflation rates below, but close to, 2% over the medium term’. The minimum purchased will therefore be €1,080bn and the final figure may be well above that .

One area of market debate ahead of the decision was the issue of risk sharing-  the ECB had shared the risk of the Securities Market Programme ( a previous and limited excursion into the sovereign debt market)  but there was some opposition to this in terms of QE, notably from Germany. In the event 12% of the purchases will be European institutional debt and all the risk of that will be shared, with the ECB also purchasing another 8% of debt on its own books. Consequently 80% of bonds purchased will be at the risk  of national central banks, implying over 90% of bonds excluding the European institutional debt.

Another question was which sovereign  bonds to buy and the ECB decided to allocate purchases by using the capital key ( each national bank’s contribution to the ECB’s capital). Euro countries provide only 70%  of the later so one assumes that the share will be adjusted pro rata for the euro members.  This would give Germany a figure of 25.6%, France 20.2%, Italy 17.5% and Ireland 1.7%.Clearly, then, purchases of German, French and Italian debt will dominate. If one assumes that €50bn of the monthly purchase is sovereign debt (the rest private sector and European Institutions) the figure for Ireland would be €0.8bn against over €12bn for Germany. The respective debt markets are very different in size though so it is more meaningful to estimate how much of the market would be owned by central banks after 18 months and that gives some interesting results; the central bank would hold 19% of Portugal’s debt, over 14% in Germany, some 13% in Ireland but less than 9% in Italy.  Indeed, in some of the smaller EA  countries with little debt the scheme would imply less than half the debt left in private hands,  and so the ECB announced certain limits, including 30% of the issuer as a maximum.

What  impact will it have on the real economy? When asked, Draghi put forward three  effects. The scheme  is a very significant move for the ECB and hence may boost inflation expectations. Second it will lower funding costs further and hence  may stimulate credit growth and spending. Third it will strengthen the ECB’s forward guidance on interest rates. He did not add it has already resulted in a currency depreciation. Will it work? QE in the UK and the US certainly seemed to boost equity markets and growth did pick up, although core inflation in both economies is still below respective central bank inflation targets. Draghi himself does not seem too hopeful – he responded  to a question about the risks of hyper-inflation when central banks print money by pointing out that  that inflation has not taken off elsewhere in the wake of QE. This begs the obvious question as to its usefulness as a tool in generating inflation in the EA, such is the weakness of domestic demand, but the ECB is clearly desperate to try everything in an envoronmnet when an alternative, expanding fiscal  policy, is deemed verboten.