Maestro Mario at His ‘Chest Thumping Best’: ECB Purchases of Public Debt Begin March 9 (3/09)     Print

spellmanBy James D. Spellman, Strategic Communications, LLC

The European Central Bank announced last week it will begin buying €60 billion ($66.49 billion) of government and private bonds on Monday (March 9) in its most intensive effort yet to avert a deflationary spiral and jumpstart economic growth. 

European stock markets immediately rallied to close at their highest levels since November 2007, the start of the financial crisis, as inflation expectations rose and the euro slipped to an 11 and ½ year low.

 

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 Source:  Holly Ellyatt, Matt Clinch, and Katy Barnato, “CNBC, Europe Markets Cheered by ECB as It Sets Date for QE.”  CNBC, March 5, 2015. http://www.cnbc.com/id/102478616#

 

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Source:  Wall Street Journal, Money Beat, “The ECB’s March Press Conference.”  March 5, 2015.  http://blogs.wsj.com/moneybeat/2015/03/05/the-ecbs-march-press-conference-live/?mod=djemalertMARKET .

Stressing the recently improved outlook for the Eurozone in economic growth and inflation, ECB President Mario Draghi said the massive program of buying sovereign debt (the “public sector purchase program” PSPP) will continue until at least September 2016.  There was “absolutely no reason” to do otherwise, he insisted. [1]

“This was Draghi at his chest thumping best,” said Marc Ostwald of ADM Investor Services, “boasting of the ECB’s success in bringing down long-term interest rates, and corporate lending rates (emphasizing convergence across the Eurozone, though omitting the fact that this does not apply to Greece and Cyprus), even before the actual QE program has started.” [2]

Prior to the March 5 announcement, it was unclear how the central bank could purchase that much government debt monthly because the eligible pool of bonds was estimated to be smaller than the €1.1 trillion ($1.22 trillion) total Draghi committed to in January.  With much uninvested cash on the sidelines and banks obligated to hold top-tier assets, notably government debt, some analysts argued the ECB would not be able to find enough eurozone sovereign bonds.  And with some government debt paying negative interest, an incomprehensible situation in which lenders pay borrowers to take their money, analysts puzzled over how the ECB could include that debt in its purchases to meet the monthly buying target.

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Source:  Ralph Atkins, “Eurozone’s march to QE enters its final stages.”  Financial Times, March 5, 2015.  www.ft.com .

Addressing these concerns, Draghi announced its purchases will include “international organizations and multilateral development banks.”  (These are:  Council of Europe Development Bank;  European Atomic Energy Community; European Financial Stability Facility; European Stability Mechanism; European Investment Bank; European Union; Nordic Investment Bank; Caisse d'amortissement de la dette sociale (CADES); Union Nationale Interprofessionnelle pour l'Emploi dans l'Industrie et le Commerce (UNEDIC); Instituto de Credito Oficial; Kreditanstalt fuer Wiederaufbau; Landeskreditbank Baden-Württemberg Foerderbank; Landwirtschaftliche Rentenbank; and, NRW.Bank.)  National central banks in the 19-country bloc will be able to purchase debt from these organizations if there isn’t enough of their country’s government debt to meet targets in which a country’s allocation of the total PSPP obligations is equal to its percentage of capital in the ECB.  The ECB would purchase sovereign debt with negative interest if that debt’s yield is above the ECB’s rate for commercial bank deposits, or minus 0.2 percent, roughly the current rate for two-year German bonds.  "There may be complexities. We think they are not relevant," Draghi said, noting that more than half of the eurozone sovereign bonds were held outside the currency area.

"The latest economic data, and particularly survey evidence available up to February, point to some further improvements in economic activity at the beginning of this year," Draghi said.  Eurozone growth is projected at 1.5 percent in 2015 (up from the ECB’s previous forecast of 1.0 percent), 1.9 percent in 2016 (up from 1.5 percent), and 2.1 percent in 2017.  "Looking ahead, we expect the economic recovery to broaden and strengthen gradually."  The euro’s fall, the ECB’s QE decision, and the decline in oil prices were the reasons for the upward revision, Draghi said.

spellman 030915 graph4Source:  Paul Hannon and Todd Buell, “ECB Gives Start Date for Bond Buying, Keeps Interest Rates Unchanged.”  Wall Street Journal, March 5, 2015.  http://www.wsj.com/articles/ecb-keeps-interest-rates-unchanged-1425559615

While a Reuters survey[3] of economists suggests Draghi needs to be more convincing, with only half of the economists polled seeing bond buying as helping inflation to rise but below two percent ECB target, inflation expectations have risen, as demonstrated by the rise in rates for five-year forward interest rate swap hitting 1.7 percent, 30 basis points shy of the ECB 2.0 percent target.

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Source:  “ECB poised to raise funding for Greek banks as euro falls to 12-year low,” Daily Telegraph, March 5, 2015.  http://www.telegraph.co.uk/finance/economics/11451105/European-Central-Bank-readies-for-quantitative-easing.html

As to Greece, Draghi said the ECB would resume financing to Greek banks after Athens reaches a deal with the Eurozone countries.  “The ECB is the first to wish to restart lending to the Greek economy providing the conditions are in place,” he said, that there is "a process which suggests successful completion of reviews."   The ECB doubled lending to Greece in the last few months, to €100 billion ($110 billion), or roughly 68 percent of Greece’s annual GDP, according to Draghi.  Further, “we have raised the Emergency Liquidity Assistance today by €500 million,” he said, referring to the channel the ECB has used to provide funds to Greek banks.

 

[1] Full details are available at the ECB Website: “Implementation aspects of the public sector purchase programme (PSPP).” https://www.ecb.europa.eu/mopo/liq/html/pspp.en.html. Also, see: Economist, “Let the show begin.” March 5, 2015. http://www.economist.com/blogs/freeexchange/2015/03/european-central-bank

[2] The Guardian, March 5, 2015. http://www.theguardian.com/business/live/2015/mar/05/european-central-bank-ecb-meeting-protests-cyprus-mario-draghi-live

.[3] Reuters, “European Central Bank to unleash bond buying programme on March 9.” The Independent, March 5, 2015. http://www.independent.ie/business/world/european-central-bank-to-unleash-bond-buying-programme-on-march-9-31042420.html