Latest figures for July show that, for the fourth month in a row, German government bonds bought under the European Central Bank’s public sector purchase programme fell short of the amount allowed by the ‘capital key’ allocation. Other countries have also seen significant deviations from the capital key, under which bonds are bought in proportion to the share of the ECB capital provided by each country. This figure is determined by the size of GDP and population, and is adjusted slightly to reflect the ineligibility of Greek bonds given their low credit rating.
Since April, the ECB has bought an additional €4.2bn of Italian bonds and €809m of Spanish bonds, against an under-purchase of €1.09bn for Germany and (since May) €172m for the Netherlands. The divergence suggests growing difficulties with the ECB’s quantitative easing programme and has reignited speculation about a tapering of bond purchases.
These figures mark a significant break from the pattern that existed for the two years from the start of the PSPP in March 2015 until March 2017. During that period the ECB over-purchased German and Dutch bonds by a total of €8.3bn and €2.3bn respectively. Italian and Spanish bonds were also over-purchased to compensate for the scarcity of bonds in smaller euro area countries, including Cyprus, Estonia and Portugal. However, the scale of Italian and Spanish bond over-purchasing has increased rapidly this year. Since January the ECB has overshot Italy’s adjusted capital key by an average of €920m per month and Spanish bonds by €311m per month. This compares with €264m and €181m respectively each month from the start of the PSPP to the end of 2016. In July the over-purchase of Italian bonds reached more than €1.2bn, the highest to date.
Mario Draghi, president of the ECB, reiterated in late June that the bank remains committed to QE through bond purchases. But the longer QE goes on the greater the demand will be for bonds in core countries. In coming months the amount of eligible bonds could begin to face significant strains. To avoid a sudden fall in the amount of German bonds available, or a politically toxic redistribution of the capital key to allow higher allocations to bonds from southern countries, Germany and others are scaling back the rate at which their own bonds are purchased.
The amount of German bonds bought in recent months is closer to the non-adjusted capital key figure that does not compensate for the lack of eligible bonds in smaller countries. If the monthly purchases of German debt are reduced, in line with the country’s minimum capital key amount, QE could continue for longer.
By the end of July, German bonds purchased under the PSPP totalled over €404bn, around 27% of all euro area government bonds bought under QE. As Germany is the largest economy in the euro area, this proportion is a natural consequence of the capital key. However, continued purchases could begin to push against the 33% limit imposed on the total amount of any country’s government debt that can be held by the ECB. By some estimates the 33% level for Germany could be reached by mid-2018.
Raising the upper limit – to 50% perhaps – would allow continued purchase of German bonds, and could therefore permit an extension of QE. However adjusting the rules to allow the ECB to keep purchasing German bonds, in order to justify continued purchases of Italian, Spanish and other bonds, is unlikely to satisfy critics. Germany has long argued for a scaling back of QE with a view to winding it down together, citing moral hazard, the distorting effects on countries’ risk premia and other factors.
The ECB has already made tweaks. In January it decided to include bonds with yields below the deposit facility rate of minus 0.4%. This primarily affected Germany. The weighted average maturity of German bonds fell to seven years at the end of July, a drop of over 14% since end-2016. This reflects the shorter maturity of new bonds purchased, most of which have yields below the deposit rate.
With euro area inflation remaining at 1.3% in July, down from 2% in February, monetary policy operations to boost inflation have further to go. As the ECB remains committed to doing ‘whatever it takes’ to return the euro area to stability and growth, new tools could be needed as the potential limits of QE edge ever closer.
Ben Robinson is Economist at OMFIF.