The European Central Bank may find it difficult to neutralize its government bond purchases after January, Rabobank said.
The ECB mops up the liquidity created by its purchases of distressed government bonds -- 183 billion euros ($251 billion) so far -- to prevent them from fueling inflation and ensure it can’t be accused of financing profligate governments.
Rabobank economist Elwin de Groot estimates that there is a “natural limit” of 300 billion euros the ECB can sterilize. “If it maintained a pace of 11 billion additional purchases each week, the average amount of purchases in the period August- September, it would hit that natural limit by mid-January,” De Groot said in a note to investors today.
The Frankfurt-based ECB began buying Italian and Spanish government bonds in August after Europe’s debt crisis spread. It says the purchases are aimed at ensuring transmission of its interest rates on financial markets. The decision has split the ECB council, with Executive Board member Juergen Stark resigning on Sept. 9 and Bundesbank member Jens Weidmann saying the bank should reduce the risks on its balance sheet rather than increase them.
The ECB already faces a writedown of about 20 billion euros in the case of a Greek default, “assuming an across-the-board haircut of 50 percent,” said De Groot, who is based in Utrecht, the Netherlands.
The central bank started buying government bonds in May 2010 after Greece’s first bailout. It bought more bonds last week as Italian yields soared. It said yesterday it settled 9.5 billion euros of bond purchases in the week through Nov. 4, up from 4 billion euros the previous week.
Forced Into Decision
Once it hits the limit, officials will then be forced “into a decision whether it is willing to go beyond its official mandate” of maintaining price stability and using the bond purchases to restore the monetary-policy transmission mechanism, De Groot said.
Stark said today he can’t see the ECB “ever giving in to pressure” to buy unlimited debt directly from distressed governments. ECB President Mario Draghi said Nov. 3 that acting as a lender of last resort is “not really in the ECB’s remit.”
Even so, De Groot says he “sincerely doubts” the ECB is willing to let bond markets collapse should euro-area leaders fail to deliver a solution to the sovereign debt crisis.
“In the end the ECB is the euro’s bank and we expect them to act, if only as a very last resort,” he said. “Recent developments in Italian bond markets indicate that such a moment may be drawing closer, sooner rather than later.”
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