The European Central Bank may not have as much flexibility left in its bond-buying program as Mario Draghi insists.
As the Governing Council kicks off discussion about the future of its asset purchases, the question that will loom large is how much wiggle room policy makers have to extend their 2.3 trillion-euro program ($2.7 trillion). Not much, according to two economists. They believe the ECB’s decision to wind down bond buying next year will be a matter of necessity rather a choice.
“Bond scarcity is increasing in more and more countries,” says Louis Harreau, an ECB strategist at Credit Agricole CIB in Paris. “The ECB will be forced to reduce its QE regardless of economic conditions, simply because it has no more bonds to purchase.”
But working out how much space the central bank still has is fiendishly hard. That’s because the asset-purchase program is like a three-dimensional game of chess spread over bonds from 18 euro-area states. The 19th member, Greece, is excluded from the program.
The first rule the ECB could trip over is the one that prohibits the accumulation of more than 33 percent of debt from a single country. Germany could hit this mark as early as spring if the current pace of purchases is maintained, says Commerzbank Chief Economist Joerg Kraemer. It’s long been a red line for Draghi and revisiting it now when the program is awaiting a review at the European Union’s highest court could be particularly tricky.
Yet some rules of the program are more malleable, giving the ECB potential leeway. The euro-area central banks have quotas to meet in buying each nation’s debt based on the size of their economies. But they can deviate from those capital-key guidelines and have done so for months now. A good example is Germany, where debt-buying last month hit the lowest level since the program started more than two years ago.
According to Harreau, the ECB could deviate from the capital key by a total of 5 billion euros a month, twice the amount they do now. That could ease the strain for some countries, but would still require the program to be wound down by the end of next year, he says.
And by pushing the capital key rules to the limit, the ECB may eventually face the same problem it was trying to fix in the first place. Kraemer says the bank could reduce purchases in Germany by 60 percent to make room for more bonds from countries where debt is still plentiful. But by the end of next year, the ECB would be facing the 33 percent limit not in one, but in four countries: Germany, France, Italy and Spain.
So what does that leave on the table? Policy makers could always lift their current 10 percent cap on purchases of bonds from Europe’s supranational organizations. Or they could add new classes to the program, which already includes corporate bonds, covered bonds and asset-backed securities. But there isn’t much if you want to leave current rules in place.
“It appears that the ECB’s lone viable option is to accept the legal limits and gradually scale back the purchases next year,” says Kraemer. “In a first step, it could reduce the monthly purchases to 40 billion from 60 billion euros at the start of 2018 and step back further at midyear. But by the end of 2018, the purchases are likely to be history.”