ECB bond reinvestments could be shock absorber as QE decelerates

Bloomberg

As the European Central Bank prepares to slow its bond-buying program, policy makers are considering softening the blow by highlighting a related measure — the reinvestment of maturing debt.
An average of 15 billion euros ($18 billion) a month of assets held under quantitative easing will mature next year, according to euro-area central bank officials who said the figure was presented at the last Governing Council meeting. While the plan to reinvest that cash has long been a part of policy, the ECB is concerned that investors are under-appreciating its impact, three people said. A spokesman for the central bank declined to comment.
Emphasizing the flow of spending needed to maintain its stock of holdings gives the ECB a way to play down a key risk burdening policy makers — that any decision to start reducing net asset purchases might tighten markets. The dilemma is that more than 2 trillion euros of QE so far has provided robust economic growth, spurring calls in some quarters to end bond buying, but it hasn’t yet led to sustained inflation.
“I do constantly hear people asking whether it is time to start tapering,” ECB Executive Board member Peter Praet said in an interview with De Tijd published on Saturday. “But underlying inflation remains too low. We have to be patient and persevere with our policy, a substantial stimulus is still necessary. Everyone agrees that we have to make sure that the reduction of the stimulus takes place in an
orderly manner, without any
excessive shocks.”

Be Careful
The last time the Governing Council adjusted QE, it extended purchases by nine months and slowed the monthly pace to 60 billion euros from 80 billion euros, citing an improved economic outlook. That schedule comes to an end in December, and President Mario Draghi has said the bulk of the decisions for 2018 will be taken in October. Praet said the ECB will have to “be very careful about the words we use.”
While the ECB projects inflation of 1.2 percent next year and 1.5 percent in 2019, compared with a goal of just under 2 percent, most economists surveyed by Bloomberg predict purchases will soon start to be phased out.
Yet should the monthly pace be slowed — for example to 30 billion euros — the ECB could try to mitigate any negative impact by noting that total spending including reinvestments would average about 45 billion euros.
“Sounds like we could be in store for a ‘super-stealthy taper’,”said Richard Barwell, an economist at BNP Paribas Asset Management in London. “The second stage of the taper could be downplayed as a mere adjustment just like the first, even though going from 60 to 30 billion a month in January opens up the possibility of a hard stop in July, and now the true deceleration in net bond buying could be camouflaged by focusing attention on gross purchases.”

Inevitable Decision
It’s not yet decided whether the ECB will disclose the specific value of reinvestments when it lays out next year’s plans, the people said, asking not to be named because the Governing Council’s deliberations are confidential. Details such as whether replacement purchases must match the nationality and duration of the maturing bonds also have yet to be agreed on, they said.
The ECB has two more policy meetings scheduled before the end of the year, on Oct. 26 and Dec. 14. Executive Board member Sabine Lautenschlaeger said this week that it’s time to take a decision “now” on scaling back bond purchases at the beginning of next year. Slovenian Governor Bostjan Jazbec said a decision to reduce buying will “inevitably” come but was postponed because economic
developments don’t yet support it.
Draghi, who has previously urged patience and prudence in communicating the withdrawal of stimulus, is scheduled to speak in Frankfurt on Sept. 21 and Dublin the next day.
Silver Lining
The reinvestments also offer potential room for flexibility on the type of purchases, which could help the ECB overcome any shortages.
Over half a trillion euros of debt issued by the top four beneficiary nations in the QE program — Germany, France, Italy and Spain — is due for redemption next year, with roughly 125 billion euros owned by the ECB, according to Bloomberg calculations.
Holdings will total almost 2.3 trillion euros by the end of 2017, and economists have warned that some asset classes such as German debt will soon become scarce. The ECB has already been deviating from the so-called capital key, which links the volumes of public-sector purchases by national central banks to the relative sizes of the currency bloc’s economies. That has allowed it to buy more debt from countries such as Italy and France, where availability is greater.

One consequence of the higher purchases is that they help depress yields in those nations, reducing the financing burden on governments. According to BNP’s Barwell, the pending discussions on reinvestments mean that bonus could continue.
“Once you set the precedent that reinvestments can be redeployed around the euro zone then you have the possibility that the composition of the bond portfolio could continue to shift toward Italy even when QE is done,” he said. “That would be a silver lining for Italy on an otherwise dark cloud of premature exit.”