European Central Bank sovereign QE plans expected to be unveiled tomorrow (Thursday) will be generally supportive of covered bonds, analysts forecast, albeit with the impact on the asset class depending on the size of the new programme and different in the core and the periphery.

“The most important question is on the size of the programme,” said Jan King, senior covered bond analyst at RBS, “whether there will be a limit on any additional purchases announced, in conjunction with a possible timeframe, or whether this will simply be linked to the intended target for the balance sheet size without limiting the purchasable amount.

“Those scenarios would have different implications for covered bonds.”

The ECB has previously cited restoring its balance sheet to early 2012 levels – when it was in the region of Eu1tr higher than before its TLTROs, CBPP3 and ABSPP were launched – as a target.

Economists at Société Générale have said they expect the package to include a target of Eu400bn of private assets, including CBPP3, and Eu500bn-Eu600bn of sovereign assets, though they do not anticipate any volume limits on specific programmes to be announced.

“We are not sure they will have all the details announced tomorrow,” added Cristina Costa, senior covered bond analyst at SG. “It might be an overarching statement saying they will proceed with QE, and then a month or so later we might get some more details.”

Some believe the ECB may surprise the market by going further, and announcing that it wants to expand its balance sheet beyond the level previously stated.

“With the low oil price, etc, the risk of deflation has actually increased,” said Joost Beaumont, senior fixed income strategist at ABN Amro. “Surprising the market and announcing they will do more to get inflation where they want it to be – that is also a possibility.”

Analysts anticipate that in a more aggressive sovereign QE scenario the ECB would remain in the covered bond market but ease the pace of its covered bond purchases, which is at an average of Eu522m per day.

“We think that this could mean that the spreads of govvies tighten a bit more,” said Costa. “There’s already been significant tightening since rumours surfaced of QE in November/December.

“This would mean that covered bonds would become more attractive vis-à-vis govvies. So on the core segments, we think that French and German covered bonds could look even more attractive than they do today.”

RBS analysts expect that if there is no limit on additional purchases and it is credible that the intended balance sheet size will be achieved, the pressure on CBPP3 will be reduced, with the share of covered bonds in Austria, Finland, France, Germany, Italy, and the Netherlands amongst the ECB’s pool of assets to decrease markedly.

“In terms of spread reaction, we would expect to see some further widening of covered bonds, both versus swaps and sovereigns,” said King.

“We expect the CBPP3 backstop to remain in place but covered bonds should underperform near-term to adjust relative value.”

While the impact of QE has already been priced in to some extent, analysts said, spreads could be further affected.

“In short it will normalise the balance between covered bonds and government bonds, so while CBPP3 has been resulting in big spread tightening, we now actually see government bonds outperforming covered bonds, especially in the core,” said Beaumont.

“In Finland, the Netherlands, Germany and Austria, government bonds have started to outperform covered bonds since the start of the year. If I look, for instance, at the Netherlands, in the seven year maturity the spread between covered bonds and government bonds is actually back at summer, pre-CBPP3 announcement levels.

“This actually makes covered bonds gain value in a relative sense versus government bonds.”

However, if the new programme is limited in size and timing and it is not credible that the ECB’s balance sheet target will be reached without a further programme, pressure would remain on CBPP3, said King. In this scenario, RBS analysts expect CBPP3 to have purchased around Eu140bn of covered bonds after one year.

“Assuming that the amount of additional purchases would be distributed according to the capital key, a relatively large percentage of available outstanding covered bonds would still need to be bought in Belgium, Germany, Italy and the Netherlands,” said King.

“We would expect covered bonds spreads to tighten both versus swaps and sovereigns, reversing the widening seen since November.”

Analysts also noted that whichever route the ECB takes, the implications for covered bonds will be different in core regions and in the periphery.

“The question is: how much is this already priced in in covered bonds?” said Bernd Volk, head of covered bond research at Deutsche Bank. “It seems a lot, but our strategists expect some further tightening in the periphery.

“So that’s why – if it would be sizeable and our strategists are right – Portuguese sovereign bonds, for example, would tighten and then covered bonds would, I would argue, underperform.”

Beaumont agreed that sovereign QE has already been priced in by the market in some core countries while there is more scope for spreads to shift in the periphery.

“In the periphery actually the pricing in of QE versus covereds has not made a huge run so far, so there I think a switch out of covereds into government bonds is still quite valuable,” he added.