MARKET MOVER - BNP PARIBAS - Investment Services India

ECB: QE through the Back Door?
• We suspect that the apparent contradiction
between the phenomenon of wider peripheral
spreads but good peripheral government
auction results could be reconciled by local
banks being the marginal buyers at auctions,
with financing coming from the ECB.
• While some of the effects of this are likely to
be similar to that under QE, we would argue that
this is not QE through the back door, not least
because the scale will likely be small compared
with QE proper.
• Meeting a potential funding gap through
commercial banks is less unpalatable to the
ECB than the ECB buying peripheral debt on its
own account and the EFSF looks as though it
was not meant to be drawn upon. What is
happening is the ‘least worst’ option.
Chart 1: ECB Government Bond Purchases
18
16
14
12
10
8
6
4
2
0
Source: ECB
ECB Purchases under the
Securities Markets Programme (EURbn)
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19
Weeks from the Start of the Programme
Chart 2: Portuguese and Irish 10y Bond
Spreads to Bund (bp)
• The practice may make the ECB’s exit
strategy a bit trickier than otherwise
There has rightly been a lot of attention about the
Fed’s throwing the door open to QE in its latest
statement. The market finally seems to have realised
that the deflation warning bells are ringing (we’ve
been banging on about the danger of this for nearly
two years).
But the ECB has eschewed QE and has only bought
a small quantity of peripheral bonds (EUR 61.6bn in
total, Chart 1) for explicitly fiscal/market stability
reasons rather than as a monetary policy initiative.
There is more than one way to skin a cat and there is
more than one way to QE. Let’s examine what’s been
happening.
First, in the bond markets, Ireland’s 10y bond spread
to bunds reached 408bp recently – well above its
high of around 310bp in May. Portugal’s spread has
gone to 396bp compared with a high of 385bp in May
(Chart 2). This suggests rather a low level of demand
for the debt of these countries (some investors have
withdrawn from buying these countries’ debt, others
have scaled back a lot after having been burnt). At
the same time, the auctions for peripheral debt seem
to have been going remarkably well, suggesting good
demand.
Simultaneous signs of poor demand for a country’s
debt in the secondary market but good take-up at
auctions seem in conflict. How to square the circle?
One hypothesis is that the people buying in the
auctions are not the same bunch as those holding
the stock. In particular, there are strong suspicions
Source: Reuters EcoWin Pro
that a lot of bids in the auctions are coming from local
banks. The portion of combined liabilities of the
periphery (Greece, Ireland, and Portugal) funded with
the central bank reached 10.1% in July. That
compares with 7% in January and an average of
1.8% between 2001 and 2007 (Chart 3). The lower
volatility of the 5y CDS spread also supports this
conclusion. The latest monetary statistics from the
ECB relate to July and do not show the big increase
in credit to governments that our hypothesis about
the auctions would suggest. However, we put this
down to local banks’ buying increased amounts of
local debt being a relatively recent phenomenon.
How are the banks financing these purchases?
Probably by repoing the securities with the ECB. This
is where the claim of QE by the back door comes in.
If the ECB lends funds to banks and the banks use
those to purchase govvies, isn’t this akin to QE by
the back door or through an agent, rather than acting
Paul Mortimer-Lee 23 September 2010
Market Mover
8
www.GlobalMarkets.bnpparibas.com