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Reuters: Extending QE challenges ECB's bond holding limits

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https://www.reuters.com/article/2015/09/30/us-markets-bonds-ecb-idUSKCN0RU20M20150930

Extending quantitative easing challenges ECB's bond holding limits

LONDON | By Marius Zaharia

If the European Central Bank decides to extend its asset-purchase program in response to global growth risks and flatlining inflation, it could hit its self-imposed limits on bond ownership in several countries within a year.

Analysts say this would happen first in Portugal and Finland, followed closely by the most important euro zone member, Germany.

The limits on individual bond holdings, set by the ECB to avoid becoming mired in any future debt restructurings, were raised for most government bonds to 33 percent from 25 percent earlier this month.

Other factors defining how long the ECB could extend QE include a ban on holding more than a third of any country's government debt and the fact that bonds must be bought in proportion to each country's contribution to the ECB's capital.

If the ECB hits those limits in Germany, it could, in theory, buy other low-risk German assets such as corporate debt or government agency debt.

And if even more easing were necessary, analysts say the ECB would simply scrap the limits on the German assets it can buy.

But would the ECB take a similar decision in junk-rated Portugal, or would it simply leave a country it has publicly praised for its economic reforms out of a stimulus program?

If Portugal, which had to be bailed out in 2011 needs to restructure its still onerous debt in the foreseeable future, the ECB would find it hard to avoid any losses if it held more than a third of its debt.

"The limits are important. The higher the share of the market you own the more problematic it becomes to engineer a restructuring if needed down the line," said Luca Cazzulani, rate strategist at UniCredit, who estimates the limit would be reached in Portugal as soon as the current trillion-euro QE program ends in September 2016.

"This is the trade-off, but I don't know where they would put themselves in this trade-off."

CREDIBILITY

Working out how long extended QE might last is difficult. Analysts must make assumptions on the future price of the bonds and the pace of government debt issuance, among others. Bonds from Italy, Spain or Portugal that the ECB bought at the height of the crisis under a previous scheme called the Securities Markets Programme (SMP), which count toward the totals, further complicates the picture.

Cazzulani, who does not include future debt issuance in his estimates, says the ECB could buy German debt for seven more months at today's 60 billion euros per month pace after the current scheme ends.

Citi strategists, who assume no change in the pace of debt issuance but do not include SMP purchases, say extended QE would first run into ECB limit in Finland, then in Germany, at around the same time in October 2017.

That may seem as a long way off, but ratings agency Standard & Poor's has said it expects QE to reach 2.4 trillion and be extended to mid-2018.

If the limit were reached in Finland or Portugal, "they would fudge it", says Harvinder Sian, global head of G10 rates strategy at Citi. "These countries are not systemically important."

In practice, they would probably slow down bond purchases in these countries before the limit was reached.

In the end, discussion of limits on QE, which risk leaving the ECB without ammunition, may be academic.

"If the ECB wants to do it, they will do it and ignore any of the previous limits they previously imposed on themselves," said Marius Daheim, senior fixed income strategist at SEB.

"If they feel it really is economically necessary to expand QE they will not back off just because it would violate 25 or 33 percent buying restrictions. That could be the maximum loss of credibility they could impose on themselves."