ECB: an impressive QE

The ECB has just announced its much awaited large scale asset purchase program, the key features of which are:

1. Monthly asset purchases of € 60bn

• Encompassing the already existing ABS and covered bonds programs (currently €13 bn per month), to which will be added agency and government bonds, while corporate bonds are not included,

• With the view of expanding the ECB’s balance sheet until there is a “sustained adjustment in the path of inflation which is consistent with the aim of achieving inflation rates below, but close to 2% over the medium term”. The program will begin in March and is intended to last until at least September 2016, meaning total purchases of € 1.1tn, although it could be extended beyond that date should it be necessary to boost inflation.

• Purchased securities will be investment grade with additional eligibility criteria for countries under aid plans, meaning that, depending on upcoming political developments, Greek securities, in particular, could be bought in due course.

• Maturities targeted will be 2 to 30 year, with the possibility to buy negative yield securities.

• A 33% per issuer and 25% per issue limit will apply. The issuer limit is an important point for countries that already have a substantial part of their debt held by the Eurosystem (Ireland, Greece …). The issue limit has been stressed by Mario Draghi to assert that the ECB will be fully pari passu, as the ECB will not have, alone, the required minority votes to block the implementation of collective action clauses, should there be a default on some of these securities.

• Subject to the above conditions, amounts bought will be according to the ECB’s capital key.

2. Unlike previous public asset buying program, such as the implemented SMP or the announced but not implemented OMT program, there will not be full risk sharing. The risk will be shared only on 20% of the combined agency and government securities purchases. As agency bonds will be 12% of the purchases, only 8% of the combined amount will be government bonds subject to risk sharing (or roughly 9% of the total government bonds purchases).

3. Regarding the purchase program, there was unanimity in considering it to be a monetary policy tool, although there was only a large majority in favor of starting this program in March. There was unanimity in approving the risk sharing framework.

In addition, the applicable interest rate applicable to future TLTRO operations will be lowered by 10 basis points (5 bps vs the previous 15 bps).

Analysis

In our view, this program goes beyond expectations in terms of size, and even more so with the confirmation that it could be open ended, with a possibility to extend it further in time should inflation fail to pick-up, and that the ECB will be pari passu, thereby avoiding to increase the credit risk borne by private holders of government bonds. The projected amount of agency bonds purchases also appears very large relative to the outstanding amount.

The absence of full risk sharing, an apparent necessary condition to mitigate the concerns of some governments, will not affect flows and should not affect, over the short term, the effectiveness of the program in terms of monetary policy. While we could think of cases where this could become a major issue, in some potential new crisis situations, we also believe the ECB would have time to deploy new adequate tools (such as OMT …) should such a situation arise.

In terms of monetary policy, we consider that with this program the ECB does deliver in the sense that it can indeed be the adequate monetary tool to fend off deflationary pressure.

It will act through a number of channels among which interest rate, liquidity, wealth effect and forex channels, whose effects has already partly been felt in anticipation, to which should now be added confidence channels due to the program’s credibility with its potential open ended feature.

It will add to a number of positive factors at play which lead us to anticipate a slight improvement of the Eurozone’s economic outlook in 2015, although it should be kept in mind that this is only the monetary policy instrument of the toolbox, with limited powers to revive the desperately slow dynamics of internal demand and that, as Mario Draghi reminded once more, a more stimulative fiscal stance together with structural reforms are, of course, mandatory, to consolidate the still weak Eurozone recovery. The ball is now back in the court of governments to deliver progress on these steps where there has been some advances, but not enough.