CBPP3 is not about to end
The European Central Bank is “reaching the limits” of its covered bond purchase programme (CBPP3) according ECB board member Ewald Nowotny, but that does not mean it is about to stop buying.
Ending CBPP3 would send the wrong signal to the market about the central bank's commitment to suppressing funding costs. It would cause many to question if other purchase programmes are also in their twilight — a thought that could easily send yields skyrocketing, defeating the ECB's goal. That's why QE won't end in March 2017, as some have said Nowotny's comments imply.
In light of the central bank’s progressively lower purchases his comment is more a statement of fact. At little over €100m, the average daily rate of secondary covered bonds purchases fell to its lowest this year two weeks ago. ABN Amro researchers estimate the ECB bought €3.6bn in October — barely half of the volume purchased at the start of this year and considerably below last year’s €10bn monthly average.
The fact that the ECB already owns over 30% of the eligible market means it is coming up against natural barriers. Almost every investor that was going to sell has by now probably sold. Those that are left are more likely to hold their investments until they mature. That explains why secondary market offers have become increasingly hard to find, and that is why the ECB probably won’t be able to step up purchases in the secondary market. However, it is freely able to continue buying in the primary market and is widely expected to continue doing so.
Even though it seems likely the programme will be extended for six months, the rate of purchasing may well continue to slow. Economists at Société Générale said on Tuesday that “the inflation outlook, confidence in the effectiveness of past measures, the scarcity of assets and rising concerns over adverse side-effects from unconventional monetary policy are the key reasons for starting tapering.”
Even in the event the ECB decides to pull out of CBPP3 from April 2017, it has committed to reinvest redeeming bonds. For the CBPP3 programme alone this should ensure purchases of €19bn next year, rising each year until 2020 when annual redemptions peak at €26bn, according Crédit Agricole’s covered bond research team. After 2020, redemptions progressively fall to less than €5bn after 2026.
But it's up for debate whether covered bond redemptions in the ECB’s portfolio will be reinvested back into the same asset class. They may only be reinvested in the asset classes that offer the best liquidity or provide the greatest flexibility, “rather than necessarily in the covered bond market itself,” said Commerzbank analysts. The Commerzbank team note that this year's higher CBPP3 redemptions did not lead to higher purchases, but rather the opposite. Hence rising redemptions will not necessarily provide a natural floor for covered bond purchases next year, or any year thereafter.
In light of these factors, it seems likely the ECB will remain a dominant player through 2017 even if actual volumes continue to decline gradually.