July 19, 2016 / 3:50 PM / 3 years ago

Politically sensitive tweaks to ECB bond scheme would only buy weeks

* ECB expected to tackle growing bond scarcity problem

* Banks say changes to QE weighting least effective

* Estimates show may extend purchases only 5-8 weeks

By John Geddie

LONDON, July 19 (Reuters) - The ECB is running out of bonds to buy under its 1.7 trillion euro stimulus scheme, but bank estimates show one of the most widely mooted options for tackling the problem may be the least effective.

The European Central Bank has been buying euro zone government bonds since March 2015 with the aim of lowering borrowing costs and igniting growth and inflation. However, its own rules mean it is struggling to find eligible bonds to buy in some countries, notably Germany.

Bank estimates show that a shift to buying bonds in line with a country’s debt rather than the size of its economy, as some reports have said the ECB was considering, would only add five to eight weeks to a scheme some predict will hit the buffers within months.

Reports that the ECB was considering such a move sent bond yields in the likes of indebted Italy to one-year lows earlier this month. Despite ECB sources later denying such stories, yields have stayed depressed, suggesting some investors still think it a possibility.

“It won’t solve the issue and it is very politically sensitive,” Nordea strategist Piet Philip Christiansen said. “I don’t think they will do it.”

The ECB has a number of rules for its purchase programme including limits on the maturity, yield and share of individual bonds it buys. Overall, it buys bonds according to each country’s shareholding in the bank, the so-called capital key.

Demand for safe-haven debt since Britain’s vote to leave the European Union has pushed yields on more than half of eligible German bonds below the deposit rate, the lower limit for ECB purchases, leading some to predict the central bank may run out of these bonds to buy as soon as October.

The ECB has said it has flexibility to keep the scheme running until its scheduled end in March 2017 or beyond. But any change to the capital key model would have heavy political ramifications, especially in Germany which faces elections next year amid growing unease about QE, as it would mean the ECB potentially buying a larger share of riskier debt.

The ECB is expected to discuss the bond scarcity issue at its policy meeting on Thursday, but some analysts say the relatively slight impact of changes to the capital key means its is unlikely to be the banks’ chosen option.


Analysts at Nordea say buying bonds in proportion to a country's debt would reduce monthly purchases of German bonds from 15.8 billion to 13.8 billion euros, with a corresponding increase in Italy from 10.8 billion to 13.9 billion euros. Purchases of Spanish debt would fall, as this graphic shows: tmsnrt.rs/29Piqxf

It does little to cure the problem of hitting limits on German debt. According to Nordea, it would buy the ECB an additional five weeks, allowing them to extend QE from mid-March to late April 2017.

Goldman Sachs says changes to the capital key would allow a two-month extension of German purchases, while other options such as changing issue limits or removing yield constraints would give the programme an extra four or 10 months, respectively.

“Shifting away from the capital key (to a debt market capitalisation key) is likely to be the least effective solution to the Bund scarcity problem,” Rohan Khanna, a researcher at Goldman Sachs.

Even some investors who have been ploughing back into low-rated euro zone bonds in recent weeks as speculation of more ECB easing has risen, are sceptical such a change would make much difference.

“If you do it by market size then it increases the importance of the Italian market but the German market is also very large so it doesn’t do much in terms of reducing those purchases,” said Myles Bradshaw, the head of Amundi’s flagship bond fund.

Yet others argue that directing money to Italy, which is battling a banking crisis and faces an October referendum that could topple its government, would be seen as an important support.

“The market reaction was not about doing the maths,” said Cosimo Marasciulo, head of European government bonds at Pioneer, said the fund had taken an overweight position in Italian bonds for the first time this year. “It was confirmation that the ECB will act as a backstop for sovereign bonds.” (Graphic by Nigel Stephenson; Editing by Hugh Lawson)

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