The European Central Bank (ECB) is to start buying up sovereign bonds from 9 March. Its president, Mario Draghi, believes that the programme of unprecedented monetary stimulus in the Eurozone will succeed in stemming the threat of deflation in the region.
Next week will see an enormous machinery set in motion for the purchase of public debt on a mass scale from the 19 countries in the monetary union. Known as quantitative easing (QE), this has now been renamed by the ECB as the Public Sector Purchase Programme (PSPP) and will consist of bond purchases up to €60bn per month.
“Our monetary policy decisions have worked and it is with some degree of satisfaction that the Governing Council has recognized this,” said Draghi at the press conference on 5 March, after the ECB meeting in Nicosia, the Cyprus capital. “The positive effects has already been felt” before the programme has come into force.
The guardian of the euro is keeping its promise to “do whatever it takes” to save the single currency and launch the Eurozone into a new era of monetary policy, which the US has already had successful experience of in the past. The ECB is therefore entering uncharted waters with all its heavy artillery. This comes on the back of other measures, such as the two cuts in interest rates it has made since June, and the purchase of private sector assets which, until now, have not been sufficient to raise inflation.
Growth forecasts have been revised upwards by the ECB. The Eurozone economy is now set to grow by 1.5% this year and by 1.9% in 2016, compared with 1% and 1.5% respectively that were the previous estimates. For 2017, the ECB has released its first forecast: 2.1% growth.
The ECB is also confident that inflation is on the right track to meet its target, i.e. below but close to 2%. However, this will not be apparent in the short term. For this year it expects consumer prices to stagnate before rebounding by 1.5% in 2016 and 1.8% in 2017. The Bank has kept interest rates at historic lows of 0.05%, as expected.
Draghi commented that the announcement he made on QE in January has already helped the economy. He also pointed out that “the favourable impact of low oil prices” will contribute to the recovery, as it will increase consumer spending and cut costs for businesses. However, he warned that this programme will be the last measure in a series of stimuli. From now on, the improvement in the economic situation will depend on other players. The Italian banker has warned the governments of the member states that a slow pace in putting structural reforms into place would undermine the recovery.
Doubts about PSPP
PSPP also carries its own risks. First, there are not enough bonds available in the market to meet the ECB’s commitment to purchase up to €1.1 trn at the rate of €60bn per month. Moreover, if the nascent economic recovery in Europe is consolidated rapidly, the Draghi plan would become obsolete before it is fully operational.
Another major risk is that Greece distances itself so much from EU guidelines that this once again jeopardizes the integrity of the euro. Indeed, the ECB has extended the emergency liquidity assistance to Greece to the sum of €68.8bn euros, but will not buy Greek bonds.
Another question raised by the PSPP is the dilemma that banks will have when deciding whether or not to sell their debt portfolios to the ECB. The fact is that some banks bought bonds with yields of 7%. “The benefit they would obtain in the potential sale already figures directly in their accounts, when their portfolio is reassessed at market value with ‘mark to market’ [accounting]”, says Javier Dominguez, Managing Partner of Auriga Global Investors.
The market reaction to Draghi’s comments was not long in coming. European shares have risen and bond yields have fallen, while the euro briefly lost its $1.10 per unit level for the first time since September 2003.
Key points of PSPP:
- Purchases under this programme will begin on 9 March and will amount to €60bn per month.
- These will go on until September 2016, but they could go further if the ECB does not observe sufficient adjustment of the inflation rate to be consistent with the objective of keeping it below but close to 2%.
- Purchases will be made on the basis of the weight of each country in the ECB’s capital. This means that 25% of buying will be German debt, 20% – French debt; 17% – Italian debt; and 13% – Spanish debt.
- 80% of the purchases will be made through the national central banks (NCBs), the remaining 20% (the only amount which will be mutualised) will be handled by the ECB, shared out between 12% in bonds of supranational institutions and 8% in sovereign bonds.
- In the event that an NCB has no market available to cover its weighting, the ECB bond will allow it to buy alternative bonds in other countries in the Eurozone, to thus reach the €60bn a month of the PSPP.
- The ECB will not purchase more than 25% of any issue of public debt to avoid having a blocking majority in the case of any debt restructuring.
- Purchases will always be in the secondary market. The ECB is forbidden by its statutes to participate in member state public debt issues (primary market).
- The ECB will buy bonds with negative yields, provided that this income is not below the interest rate on the deposit facility, currently at -0.2%.
- The ECB will buy bonds with maturities of between 2 and 30 years.
An initial list of international or supranational institutions located in the euro area and of agencies located in the euro area whose securities are eligible for the PSPP can be found here. A Q&A on PSPP can be found here.