ETF Securities Research Blog

ECB’s minutes reveal concerns over Eurozone bonds scarcity

The minutes of the ECB’s December meeting, published yesterday, revealed that the increasing scarcity of high quality government bonds such as German bunds, was at the centre of the two main decisions taken by the Governing Council. Overall, the ongoing deleveraging of the public and the private sectors, coupled with the ECB’s purchases and the elevated demand for high quality Eurozone government bonds have aggravated the shortage of supply. We believe that this is a warning signal that QE in its current form has reached its practical limit in Europe. While some Eurozone governments have procrastinated in using fiscal stimulus, they will soon no longer have the choice but to implement structural reforms to support the economic recovery. Consequently, we believe the rotation from monetary to fiscal stimulus has not been fully priced into the market yet. Thus, we expect Eurozone yield curves to gradually steepen in 2017.

Regarding the extension of the Asset Purchase Programme (APP), the minutes revealed that Governors debated over two options: a 6-month extension at a constant monthly pace of EUR80bn and a 9-month extension at a slower pace of EUR60bn. While the first option would have resulted in a smaller total amount of additional purchases (EUR480bn against EUR540bn for the second option), liquidity-related challenges drove the discussion toward the latter option. The first option would have necessitated an additional modification of the parameters of the programme, namely a change in the capital key – the proportion of bonds the ECB can buy from each country defined as the capital participation of the country to the ECB balance sheet.

The ECB’s APP has supported bond valuations and reduced the supply of high quality bonds, making government collateral more expensive, leading daily volumes and rates in the European repo market to decline. In order to reduce these unintended consequences on the repo market, the ECB provides a securities lending programme (SLP) where the holdings of securities purchased under the Public Sector Purchase Programme are available for securities lending. The minutes revealed that the relaxation of the conditions to borrow collateral from the SLP was primarily to address the increasing scarcity of high quality bonds and collateral. Accordingly, ECB’s Governors announced in December that cash would be accepted as collateral against securities (no longer exclusively high quality bonds). Despite the marginal revisions of the parameters of the QE to smooth its implementation, the ECB’s monetary stimulus seems close to its practical limit, suggesting the Eurozone yields have reached their floor.