ECB faces bond-buying shuffle with QE extension on the cards

Bloomberg

The European Central Bank might need to change the rules of the game if it wants to keep playing in the bond market.
President Mario Draghi’s 1.7 trillion-euro ($1.9 trillion) asset-purchase program is scheduled to end in just six months, but euro-area inflation is still weak and the full shock of the UK’s Brexit vote could be yet to come. If the ECB extends quantitative easing — as most economists surveyed by Bloomberg predict — policy makers may have to reconsider what they can buy.
When the Governing Council gathers on Wednesday for a two-day policy meeting, its self-imposed purchase restrictions are likely to be a focal point, even if no final decision is taken. Draghi said at the last gathering in July that officials have shown they can adjust QE when required, and that there should be no doubt they can stick to their pledge to keep spending 80 billion euros a month until March 2017 “and beyond if needed.”
Here are the key options:
Option 1: Changing the Issue and Issuer Limits
Rule: The maximum share of any single public-sector security that euro-area central banks can hold — known as the issue limit — has already been raised to 33 percent from 25 percent for bonds without collective-action clauses. The cutoffs are to prevent the ECB from gaining the power to block any restructuring plans and to avoid it becoming a dominant investor. The 33 percent threshold also applies to the exposure to any one bond issuer.
Solution: Raising the issue limit on bonds without collective-action clauses should be “fairly uncontentious,” according to a note by HSBC Holdings Plc. Increasing the limits is the “most likely” choice, according to Bloomberg Intelligence economists. The issuer limit might also be increased.
Cons: The ECB could distort markets. It could also be viewed as financing government deficits — which is illegal under European Union law.
Option 2: Changing the Deposit-Rate Floor
Rule: The ECB must only buy debt with a yield higher than the deposit rate, currently minus 0.4 percent. The rule ensures that losses booked by the central bank when it buys negative-yielding debt are offset by the income gained from its deposit account.
Solution: Lowering or scrapping the minimum-yield requirement would be one of the easiest options to implement, according to Barclays Plc. In particular, it would increase the available pool of German bonds — two-thirds of those assets are now ineligible after concerns of a Brexit-led slowdown prompted investors to seek a haven for their cash.
Cons: National central banks — especially in Germany — would be knowingly making a loss on some of the bonds they buy. Still, that doesn’t necessarily imply losses at an aggregate level for either individual central banks or the Eurosystem.