The ECB yesterday (Thursday) confirmed the March end to PEPP, albeit cushioned by an APP boost, amid a package leaning to the hawkish side of expectations. Little impact on CBPP3 is foreseen, although an outside chance of a cut to primary market orders early in the year has been flagged.

In the wake of Omicron and questions over the permanence of inflationary pressures, the European Central Bank kept its options open, noting the Pandemic Emergency Purchase Programme (PEPP) could be resumed, saying it will maintain the Asset Purchase Programme (APP) as long as necessary to reinforce the accommodative impact of its policy rates, and regularly assessing its targeted lending operations. The reinvestment horizon for PEPP was also extended until at least the end of 2024.

However, the central bank expects the special conditions applicable under TLTRO III to end in June and net asset purchases under PEPP to end in March. PEPP buying will slow in the first quarter – with several analysts expecting €50bn-€55bn – although APP will be increased to €40bn per month in the second quarter and €30bn in the third, before returning to €20bn in the last quarter of 2022.

Some market participants and observers had anticipated an extension of PEPP in one form or another, but any such hopes were disappointed, and peripheral government bonds widened in the wake of the ECB gradually removing the PEPP “punch bowl” and replacing it with “sparkling but sober APP mineral water”, in the words of DZ analyst Daniel Lenz.

Only around €6bn of covered bonds have been bought under PEPP, and analysts saw little direct impact on the asset class from the confirmation of the March end of the programme.

The temporary boost to APP was interpreted by Danske analysts as increasing the programme’s support for covered bonds in 2022 on top of CBPP3 reinvestments and amid an anticipated increase in euro benchmark supply to around €120bn next year.

However, other analysts do not expect the additional €90bn of APP purchases across the second and third quarters to impact covered bonds significantly, with the ECB instead taking concentrating the temporary boost on buying other securities, such as those it has been buying under PEPP to cushion the end of that programme.

“We expect the increase in purchases under the APP to €40bn per 2Q 2022 to be mainly taken up by the PSPP and CSPP, and not to contribute to an increase in purchases by the CBPP3,” said Maureen Schuller, head of financials sector strategy at ING, for example.

“If anything, once total purchases under the APP are gradually tapered to €30bn in 3Q 2022 and back to €20bn per October 2022, we believe that the net buying activity under the CBPP3 could decline further, too.”

The ECB’s covered bond buying in 2022 will anyway be boosted by some €10bn more of redemptions than in 2021, and Schuller argues that the central bank could rein in CBPP3 net purchases to avoid its holdings rising much beyond the 45% share of the euro benchmark market it already owns.

“We don’t expect major direct performance implications of lower net covered bond purchase efforts,” she added. “If anything, any potential performance impact on govies or SSAs of lower public sector purchases after the PEPP ends, would be more of a concern for covered bonds to us.”

Crédit Agricole analysts also see redemption considerations as supportive of the view that the ECB taper should prove manageable for covered bonds, and forecast CBPP3 net settlements of €1.0bn-€1.5bn per month, even during Q2 (compared with €2bn per month in 2020 and €1bn in 2021).

However, they see tail risk that the ECB could reduce its primary market orders – from the prevailing 40% level – should the primary market become very crowded.

The absence of attractive new TLTRO offerings yesterday contributed to Crédit Agricole expecting around €130bn of euro benchmark supply in 2022, €10bn more than previously forecast. As previously reported, banks are expected to return to wholesale markets and covered bonds in particular as the TLTRO option falls away.

Crédit Agricole’s analysts said that should this shift be concentrated at the start of the year, resulting in as much as €25bn-€30bn of CBPP3-eligible issuance in January and correspondingly high ECB purchases, the central bank could in mid-February counter this by reducing its primary market orders, especially if heavy issuance continues.

“Not exactly realistic and clearly not our base case,” they added, “but it is not impossible either, which is why we bring it up. Should this tail-risk happen, we would expect core covered bond sectors to add another 5bp of widening.”

Previous cuts to CBPP3 orders have disrupted the primary market. Although the prevailing level of the ECB’s order has been 40% of expected issue sizes, its allocations have varied and averaged around 20%.

DZ covered bond analyst Jörg Homey is more confident about the central bank’s ongoing support for the sector, saying it can definitely continue to be relied on.

“After all, the ECB already has its hands full replacing matured bonds in its portfolio for CBPP3,” he said.

As well as taking advantage of buying opportunities at the beginning of the year, the ECB is likely to invest €4bn-€5bn per month in the covered bond market in 2022, said Homey.

“Even if the CBPP3 portfolio will not grow significantly as a result despite these substantial purchases, we believe that these purchases will dampen the pressure on covered bond spreads. We therefore expect spreads to widen only moderately at the beginning of the new year.”

Photo: ECB president Christine Lagarde at the press conference following yesterday’s governing council meeting; Credit: Sanziana Perju/ECB/Flickr