ECB Leaves Flexibility for Bond Reinvestments in Its Guidance

  • Officials commit to keep portfolio aligned with capital key
  • Redemptions increase volatility of monthly asset purchases

European Central Bank (ECB) headquarters in Frankfurt, Germany

Photographer: Krisztian Bocsi/Bloomberg

The European Central Bank may be willing to show greater flexibility in how it supports its economy when bond-buying stops. 

When policy makers extended quantitative easing to at least September, they stipulated that money from maturing debt would be reinvested in the same country for as long as the ECB keeps adding to its holdings.

In limiting that time frame, they also created some wiggle room to scatter funds from expired assets across the euro-area’s 19 nations thereafter. Greece, which has so far been excluded from QE, would stand to benefit once it’s finally deemed fit to participate.

Such shifts would allow the ECB to better control market interest rates across the region as reinvestment makes monthly bond buying more volatile. They could also potentially be delicate given President Mario Draghi’s commitment at the start of the program that asset purchases must reflect the size of the bloc’s individual economies -- reflected in the share each national central bank contributes to the institution’s capital -- and may therefore be used only on occasion and in limited fashion.

“The alignment of the stock with the capital key remains a clear goal of the ECB council,” according to Bundesbank board member Joachim Wuermeling.

The requirement that euro members must benefit proportionally from asset purchases is one of the most important features of quantitative easing -- founded on policy makers’ desire to underline that the program is monetary policy, not a prop for governments. Skepticism of bond buying runs deep in some parts of the bloc, particularly in core countries such as Germany, and has been subject to legal challenges.

Ever since the ECB started buying government bonds in March 2015 to fend off deflation in the 19-nation region, it has interpreted the program’s parameters flexibly enough to ensure that financial markets stay calm. Now that the central bank is preparing to pare back unprecedented stimulus, avoiding disruptions has become paramount.

Taper Tantrum

Policy makers are still scarred by the “taper tantrum” experienced by the Federal Reserve in 2013, when a signal that bond purchases would slow sent yields surging. 

In Europe, government securities have rallied since the Oct. 26 decision to extend asset purchases to at least September while cutting the monthly pace in half starting next year. Peripheral bonds in Spain, Italy and Portugal have been the best performers on the prospect of extended ECB support and fading political risks.

In preparing for an orderly exit from QE, the ECB started publishing data on expected redemptions last month, along with some of the parameters it applies in finding adequate replacements. It announced that it would spread out reinvestments over several months to keep a steady presence in the market and has also stressed that its “sizable” holdings of debt will continue to deliver stimulus long after actual purchases end.

Despite increased visibility about the ECB’s demand for debt over the next 12 months, uncertainty about the central banks’ involvement is running high among investors.

“The real concern is 2019,” said Martin van Vliet, senior interest rate strategist at ING Groep NV. “I know the ECB is talking about the stock effect of QE but from where I’m sitting, and talking to the traders, what does matter is that everyday there is a steady regular buying flow.”

Deviations from the capital key already occur regularly, and have led to accusations that the ECB is favoring some countries over others. The central bank has countered that those deviations are technical, and not aimed at financing profligate nations.

“There is no room for discretionary divergences from the capital key that would lead, for example, to increased purchases of bonds from specific countries,” said Bundesbank’s Wuermeling. “The distribution of purchases across countries is clearly rule-bound, subject to the control of the Eurosystem and allows deviations only due to technical reasons.”

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