ECB all but certain to keep buying bonds beyond March, ease QE rules: central bank sources

October 26, 2016 9:51 AM EDT

The headquarters of the European Central Bank (ECB) are pictured in Frankfurt, Germany, September 8, 2016. REUTERS/Ralph Orlowski/File Photo


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By Francesco Canepa and Frank Siebelt

FRANKFURT (Reuters) - The European Central Bank is nearly certain to continue buying bonds beyond its March target and to relax its constraints on the purchases to ensure it finds enough paper to buy, central bank sources have told Reuters.

The moves will come in an attempt to bolster what is being heralded as the start of an economic recovery in the euro zone.

ECB policymakers are due to decide in December on the future shape and duration of their 80 billion euros ($87.36 billion) monthly quantitative easing (QE) scheme, based on new growth and inflation forecasts.

They did not discuss specific options at last week's meeting and no policy proposal has been formulated. But sources familiar with the matter said it was all but sure that money printing would continue in some form beyond March, currently the ECB's earliest end-date.

This would be consistent with ECB President Mario Draghi's guidance last week that the Bank would keep a "very substantial degree of monetary accommodation" and his dismissal of an abrupt end to the bond scheme.

The ECB declined to comment for this article.

Whether the current monthly volume of purchases will be maintained or reduced after March has not been decided and will depend on incoming economic data, the sources said.

Recent data has shown a slight uptick in inflation and other gauges of economic activity, suggesting a nascent recovery.

Business activity in the euro zone expanded this month at the fastest pace this year while the Ifo indicator of German business confidence improved unexpectedly in October.

But with price growth still seen missing the ECB's target of almost 2 percent for at least two years, not even the most hawkish members of the ECB's Governing Council are prepared to argue bond purchases should stop in March, the sources said.

LOOSENING RULES

The extension means some of the ECB's self-imposed constraints on what it can buy will have to be eased as eligible German bonds become harder to find, the sources said.

One possible change being considered would see the ECB buying fewer bonds from countries where scarcity is starting to emerge, such as Germany, whose government debt up to five years is often ineligible because it yields less than the deposit rate.

This would be a small departure from a rule dictating that sovereign bonds be bought in proportion to the amount of capital each country has paid into the ECB, which depends on the size of its economy.

While ditching this 'capital key' altogether would invite political and even legal accusations that the ECB is financing governments, a small deviation is now seen as acceptable and well within the scope of a recent court ruling on ECB money printing, the sources said.

They noted the ECB is already deviating from the key, for example by buying fewer Portuguese and Estonian bonds than the rule dictates in recent months. Germany has typically enjoyed slightly oversized purchases as a result of that.

Another way to get around a dearth of German paper would be the relax a 'yield floor' rule barring the ECB from buying debt that yields less than its -0.40 percent deposit rate.

This option would be favored by the more hawkish ECB rate setters but the economic benefits of further depressing already negative yields are unclear.

The ECB is also considering buying more than a third of any individual bond issue, except for a few which have a specific restructuring proviso known as a collective action clause (CAC).

"It could come to a combination of measures and it will be a difficult decision," one of the central bank sources said.

ECB rate setters have so far been tight lipped in public, although growing acknowledgment by the ECB's most senior officials of the negative impact of negative interest rates on financial firms' profits suggest a further rate reduction is not likely.

Money markets no longer price in a 10 basis point cut in the ECB's deposit rate, currently at minus 0.40 percent, by year-end.

That contrasts sharply with June, when the market priced in an 80 percent chance of a cut as Britain's shock decision to quit the European Union fueled concerns about the outlook for growth and inflation. [L8N1CW3F5]

(Additional reporting by Dhara Ranasinghe Editing by Jeremy Gaunt.)



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