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QE likelihood, size debated, CBPP impact seen limited

The European Central Bank is widely expected to cut interest rates upon this week’s governing council meeting or the next, in September, but the likelihood of a relaunch of QE is less clear, as is how the next episode of any covered bond purchase programme might play out.

Since ECB president Mario Draghi said that “additional stimulus will be required” in the absence of any improvement in economic indicators at Sintra on 18 June, government bond and credit markets have rallied strongly. His comments were not only interpreted as increasing the likelihood and imminence of interest rate cuts, but also prompted speculation that it could restart the asset purchase programme (APP). In a Bank of America Merrill Lynch survey of fund managers, for example, some 60% of respondents expect more bond buying by year-end.

Among those expecting net new buying to resume – after having ended in December 2018 – are ABN Amro analysts, who anticipate a relaunch of QE from January 2020, running for nine months at EUR70bn per month. Joost Beaumont, senior fixed income strategist at ABN Amro, told The CBR he expects covered bonds to constitute 6% of monthly purchases, or some EUR4bn-EUR5bn of net purchases. On top of reinvestments of existing holdings, this would translate into some EUR6bn-EUR7bn per month.

Maureen Schuller, head of financials research at ING, has more modest expectations, of EUR15bn-EUR30bn of monthly purchases, while others are sceptical about the prospect of the ECB restarting its programmes.

“We do not expect a resumption of net QE purchases in our baseline scenario,” said BayernLB analysts, for example. “However, a reactivation of the programme cannot be ruled out.”

Expecting a stabilisation of economic conditions, DZ analysts also do not expect a revival of the ECB’s purchase programmes. Indeed, they expect QE speculation to dissipate increasingly after the summer break, potentially leading to a widening tendency.

Although the ECB is not expected to confirm any new QE until after the holiday season, it is expected to signal any such action in this week’s press conference. Schuller said that should the ECB disappoint on either front – interest rate cuts or QE – the market will definitely sell off.

“The market is already pricing in and expecting the announcement of the restarting of the purchase programme,” she said. “But I don’t think they will disappoint.”

However, she said that unlike the launch of previous covered bond purchase programmes, today the ECB’s interest rate stance has been paramount in the performance of the asset class, with speculation around a new round of buying having a relatively lower impact on the direction of the covered bond market.

Beaumont also expects a more muted reaction than that which greeted the original announcement of CBPP3, which he said “really came out of the blue”, and with monetary policy already having driven the market tighter.

He nevertheless expects spreads to tighten back to those last seen in early 2018 on the back of renewed ECB buying.

Although Commerzbank analysts are in the sceptics’ camp – “a further weakening of the economy is likely to be required for a restart of net QE purchases” – they considered the potential impact of an extension of CBPP3 and argue that the level of yields will be a stumbling block for spread narrowing.

They note that recent issuance, notably for Helaba, has shown that negative-yielding issuance is possible, but say that as yields approach the yield level of the ECB deposit rate, the added value of a covered bond investment will decline.

“This already limits the scope for further spread tightening at the short end of the curve, where this critical yield level is already being reached by core covered bonds,” said the Commerzbank analysts.

Should the ECB cut interest rates and restart QE net purchase, core covered bonds could tighten perhaps 5bp in shorter maturities, they forecast, and up to 10bp in medium maturities.

“Any stronger tightening would likely result in yield levels becoming too low for private demand.”

Photo: Mario Draghi speaking at Sintra; Credit: ECB/Flickr