MARKET MOVER - BNP PARIBAS - Investment Services India

directly to effect outright purchases as the Bank of
England has done?
We would argue, yes and no.
On the yes side:
• There is increased demand for govvies;
• This is financed ultimately by an expansion of the
central bank balance sheet (full allotment tenders
give control of the size of the ECB’s balance
sheet to the private sector);
• Broad money supply rises as does narrow
money; and
• There should be a price effect on the govvies
bought.
On the no side:
• The scale will be massively short of the scale of
QE proper (13% of GDP in the UK’s case);
• The exit for the central bank is easier – it does
not have to sell debt but merely scale back
money market assistance or alter its terms;
• The risks faced by the central bank are smaller
because the commercial banks’ capital is the first
line of defence against markdowns in the values
of government securities;
• The motivation is not monetary easing (though
the effect may be that) but fiscal support;
• It is a less overt form of QE so its effects on
asset markets and the exchange rate may be
smaller; and
• It targets portions of the EUR govvie market, not
the whole of it and so is more akin to ‘credit
easing’.
Overall, while there are similarities to QE proper, we
would see the scale and targeted nature of the
operation as ruling out the operations being seen as
QE proper.
It has a number of implications:
• It intertwines more closely the fate of the local
banks and the government;
• It reduces the appetite (low in the first place) for
the EU institutions to allow restructuring by a
sovereign as the ECB could suffer losses if the
collateral was written down (only true if the bank
pledging the collateral goes under, we admit);
Chart 3: Liabilities Funded with Central Bank
(% of Total)
20
18
Gr
16
14
12
10
8
Irl
6
4
Pt
2
Sp
0
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10
Source: Reuters EcoWin Pro
• It could risk crowding out private sector access to
bank credit;
• It may make the ECB’s exit from extraordinary
measures a bit trickier as it would have to
contemplate the effects on govvie markets as
well as money markets of the exit;
• When it comes to normalising rates some way
down the road, govvie markets may not perform
well, so the ECB would risk damaging the capital
of banks in struggling peripheral countries – also
giving it pause for thought.
Should the ECB be happy to see its facilities being
used in this way? We can speculate that it might not
like the principle of it effectively financing
governments through an agent. However, as long as
the collateral requirements are being met, why
should it worry? Its facilities are there to be used.
This is one way credit and money supply can be
boosted.
Furthermore, what are the alternatives? If institutional
demand falls short of supply, there could be a
renewed crisis in sovereign markets. The ECB is
reluctant to buy on its own account and the EFSF
appears to us as an institution that the eurozone
countries never want to be used. So local bank
buying of govvie debt, while relatively unpalatable to
the ECB, may be the least unpalatable practical
proposition.
Paul Mortimer-Lee 23 September 2010
Market Mover
9
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