Peripheral pullback: ECB bond buying hits terrible twos

The European Central Bank is marking two years to the day it bought its first bonds under its landmark quantitative easing programme.

Happy birthday, QE. Time for a toddler tantrum?

€1.5tn in assets later and the ECB has announced it will begin scaling back the size of its monthly purchases from €80bn to €60bn starting from April.

But policymakers have strongly denied they are “tapering”, or winding down, their stimulus programme, arguing instead that a slight one-step slowdown on its buying operations reflects the diminished risk of the bloc falling into deflation. Consumer price inflation hit 2 per cent for the first time in four years last month.

Still, the programme is changing, particularly as the ECB seems to be running into increasing problems in meeting its monthly QE targets in the face of a bond shortage.

To maximise its flexibility, the central bank was forced to abandon a rule that barred the purchase of government bonds yielding less than the deposit rate of minus 0.4 per cent at the start of this year, but it is still bound by limits on the proportion of each country’s debt it can buy. The amounts are dictated by a “capital key” where purchases are in line with the size of a member state’s economy.

That’s where the pullback in the so-called peripherals – the wobblier areas of the eurozone – kick in.

Data from the end of February reveal that the ECB cut back its Portuguese purchases to its lowest ever monthly level as it faces a squeeze from rules preventing it from holding more than a third of any member state’s outstanding debt.

Kim Liu at ABN Amro calculates that to keep hitting its monthly target, the ECB has been over-buying German, French, Dutch and Italian debt in recent months at the expense of the likes of Ireland, Finland and Portugal.

The chart below reflects the ECB’s deviation from its capital key over the last two years, with the relative German “over-buying” helping push up the price on its short-term bonds to all-time records in recent weeks.

But there are also questions over how long the ECB can keep snapping up German bonds.

“Because of these vast amount of purchases, we think that if the ECB would continue at its current pace that even in June the German bond holdings would hit the issue limits,” says Mr Liu.

“In order to avoid this, we think that the ECB will need to drastically slow down its German purchases in the next few months.”

These technical headaches have led to analysts at Pimco to call for an inevitable tapering in the ECB’s programme, despite any insistence from its most senior officials that inflationary pressures are still not sufficient to meet its targets.

“The rules it has set itself for the purchase of sovereign debt leave the ECB with no other choice but to taper purchases of government bonds,” says Andrew Bosworth, head of portfolio management at Pimco.

Expect Mario Draghi, ECB president, to come under questioning about the composition of its QE measures, with economists noting that the bloc’s weakest economies are in fact need of the most, not the least support.

Finland for example was the weakest performing eurozone economy after Greece at the end of 2016, with growth falling flat at 0 per cent. The eurozone’s average quarterly growth was 0.4 per cent.