European central bankers hostile to continuing the euro area’s €80bn a month quantitative easing programme are likely to praise rather than denigrate Mario Draghi, the European Central Bank president, as a tussle approaches over efforts to return euro area inflation towards the 2% target.
The tactics employed by the anti-QE faction on the ECB’s governing council will focus in coming months on understating public doubts and saluting signs of success in the ECB chief’s bid to boost the inflation rate in a bid to phase out QE from March 2017 onwards.
The ECB will decide in coming months whether and how to carry on with the QE programme, based above all on the inflation path. QE extension – even in modified or ‘tapered’ form, falling €10bn a month down to zero by November – would require the ECB to overcome self-imposed hurdles on bond-buying designed to prevent the mechanism from becoming overt monetary financing.
One big problem has been a relative shortage of German bonds, a result of the fall in German yields across much of the maturity spectrum to below minus 0.4%, the ECB’s deposit rate, which at present represents the lower interest rate limit for eligible purchases by the ECB and national central banks.
One issue under review by ECB committees is whether the ECB could change the ‘capital key’ under which ECB and NCB buying is in line with the share of euro area countries in the ECB’s equity capital (adjusted to allow for the non-eligibility of Greek bonds under current rules on credit standing).
In fact, in some important ways, the ECB has already been diverging from the capital key approach. According to OMFIF calculations, since April 2016 the ECB has stepped up its purchase of Italian and Spanish government bonds, buying an additional €3.3bn and €2.3bn of Italian and Spanish debt above the amount allowed by the capital key.
Italian and Spanish government bond purchases have exceeded their capital key in every month since March 2015 (except for a minor undershoot for Italian purchases in August 2015). The scale has increased since April 2016. Between March 2015 and March 2016 the average monthly overshoot was 0.2 percentage points and 0.13 percentage points for Italy and Spain, respectively, above their capital key share. Between April and September this year, this grew to 0.87 and 0.62 points.
Most of this adjustment reflects underpurchases of Slovenian, Portuguese and Irish debt since April. This is in addition to a more established undershooting for Latvia, Lithuania, Luxembourg, Malta, Slovakia, Cyprus and Estonia, which consistently miss their targets, owing to a dearth of eligible bonds.
The ECB has not yet undershot purchases of German bonds according to the capital key, apart from two minor deviations in January and June 2016. In September purchases of German bonds were 1.01 percentage points above the capital key, at €17.19bn (against €16.5bn under its adjusted 26.3% capital key allocation).
Even if the ECB governing council decides against continuing the current purchase size, government bond buying is not expected to fall to zero in April, following a €80bn purchase in March 2017. A taper of €10bn a month from April would increase total purchases by €280bn, bringing overall QE to €2.02tn by October 2017. Up until now public sector bonds (including government bonds and supranational institution bonds) have made up 85% of total QE purchases. Assuming this trend continues, total public sector purchases would amount to €1.72tn by the end of the taper, implying an additional €238bn from April 2017 – €214bn from individual sovereigns and the rest from supranational institutions.