June 27, 2019 / 2:38 PM / 6 months ago

Sizing up QE2: How a new round of ECB bond buys might pan out

LONDON (Reuters) - After this month’s bombshell from Mario Draghi on further monetary easing, some investors are betting on a return to bond purchases by the ECB, with debate focused on what it should buy to make the most impact.

FILE PHOTO: The headquarters of the European Central Bank (ECB) are illuminated with a giant euro sign in Frankfurt, Germany, March 12, 2016. EUTERS/Kai Pfaffenbach//File Photo

An interest rate cut is priced for September, and expectations that the European Central Bank will also launch another asset purchases program - in which corporate debt will play a bigger role - has sent the iBoxx euro corporate bond index to record highs.

Asset-backed securities and covered bonds, have also soared in the past week while five-year bond yields in Italy, also tipped as a major beneficiary of quantitative easing (QE), fell almost twice as much as Spanish, Portuguese, French and German counterparts on the day Draghi spoke.

One thing is clear: the ECB will have to think creatively, then act quickly and in size to generate traction. German 10-year bond yields, the euro zone’s borrowing benchmark, are already at minus 0.3%..

“The ECB has to come up with something that wows the market. They need to provide more not less, be radical in terms of what they do and they need to be proactive in doing it,” said Guy Miller, chief market strategist at Zurich Insurance Group.

(Graphic: The European Central Bank's QE program - tmsnrt.rs/2YgbrGJ)

Here’s an indication of what is expected.

1. Sooner rather than later

   

Estimates as to when QE2 will launch range from October to the first quarter of 2020.

NatWest Markets expects QE to resume in October for six months, anticipating an announcement in September alongside a 10 basis point rate cut.

“Having already given the forward guidance for unchanged rates until mid-2020, the downside to strengthening that with asset purchases seems low to us,” NatWest European rates strategist, Imogen Bachra, said.

Draghi’s term expires in October and with one eye on his legacy, he could use that month’s meeting to announce a November QE launch, said Jack Allen-Reynolds, senior European economist at Capital Economics.

2. Size matters

The ECB will likely kick off with monthly asset purchases of around 20-30 billion euros for six-12 months, three banks estimate.

In the first QE round, launched in March 2015, monthly purchases peaked at 80 billion euros in 2016, easing to 30 billion by December 2018 when the program ended.

NatWest expects a six-month QE program worth 180 billion euros in total, while Barclays anticipates a 20-30 billion-euro monthly scheme starting in January.

ABN Amro though predicts a 630 billion-euro program lasting nine months, so with purchases worth 70 billion euros a month.

3. Rewrite the rules

The ECB will certainly have to tweak its bond-buying rules. Currently, a “capital key” rule means the bigger an economy, the more of its debt the ECB buys. But it does apply ‘flexibility’ and will continue to do so, banks reckon. So QE2 could see it purchase more Italian, Spanish and French debt and less German paper.

Alternatively, the ECB could re-write the rules, one report suggests. It caps its holdings to no more than a third of each country’s debt but raising this ceiling to 50% would allow new net purchases of up to 1.1 trillion euros before German paper becomes scarce, Berenberg estimates.

The issuer limit was designed to prevent the ECB from becoming a “blocking minority” and voting against any future debt restructuring proposals.

Under possible solutions being studied, this constraint may be circumvented by stripping central banks of voting rights.

(Graphic: ECB PSPP - tmsnrt.rs/2EfklfI)

(Interactive version: tmsnrt.rs/2EgAulf)

4. Keeping companies

The ECB owns around 178 billion euros in corporate debt, having added the category to its asset purchases in 2016 - only a small part of the 700 billion of eligible corporate securities and dwarfed by the around 2 trillion it holds in government debt.

That suggests company bonds could play a bigger role in QE2.

Allen-Reynolds at Capital Economics expects any new program will be split 50/50 between public and corporate bonds, adding that increasing the share of corporate bonds could have a bigger market impact.

Buying corporate debt involves more risk, however. The ECB sold bonds from scandal-hit South African retailer Steinoff at a loss last year.

(Graphic: Frontloading a QE restart? - tmsnrt.rs/2FEEjBo)

5. Buy...bank bonds?

A big question is whether QE might be expanded to include bank bonds.

Jeroen van den Broek, head of DM strategy and research at ING, estimates up to 305 billion euros worth of bank debt could be eligible for QE2 purchases.

However, buying bank bonds could be problematic because of the ECB’s role as bank supervisor. Therefore it may not want to give the impression it is subsidizing the sector.

(Graphic: Could ECB QE target bank bonds? - tmsnrt.rs/2ZRdCRl)

Reporting by Dhara Ranasinghe and Virgina Furness; Additional reporting Sujata Rao; Graphics by Ritvik Carvalho; Editing by Sujata Rao and John Stonestreet

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