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The ECB cannot pretend it is a selective investor


The European Central Bank (ECB) likes to keep up the idea that it dips in and out of markets judiciously with its quantitative easing programme. This is disingenuous. Its driving force is its need to pump money into the system.

As of November, the ECB committed to buying a net €20bn assets a month, as part of its renewed quantitative easing programme. This is expected to include gross covered bond purchases of €4.5bn a month.

Last Friday, at a covered bond conference organised by the Association of German Pfandbrief Banks (VDP) and the Association for Financial Markets in Europe, an expert from the central bank responsible for purchases tried their best to convince attendees that it is not a price setter and can exercise a fair degree of price discretion.

Speaking at the event in Berlin, the ECB’s portfolio management expert stated that the central bank paid careful attention to primary flows and bought more in one asset class compared to another, in line with the variations in supply. In essence that means the ECB will buy more covered bonds in January when issuance peaks, than in August or December.

The ECB says it will be careful to minimise the distorting impact of its buying and will try to be as adaptable as it can by working closely with national central banks and adjusting to market conditions.

But quantitative easing is market distortion. 

The real driver is the ECB’s need to inflate its balance sheet by the desired amount. It’s not about value investing, looking to beat the index, or delivering a strong absolute return.

Private sector investors consider the spread in light of the credit quality of the issuer. The ECB’s mandate is simply to hit its €20bn monthly target. 

If a deal is eligible for the purchase programme it will buy up to 40% of it, provided there are enough investors to take the remaining 60%. 

Of course, the ECB is not the only buyer in the market with little price sensitivity. Banks, which need to buy for their liquidity coverage ratios, are pushed into the market whatever the price. 

But in contrast to banks, the ECB has a mandate to buy at yields below the deposit rate — where it will be the last man standing and will face no competition for assets whatsoever.

Ideally, the ECB would want to buy into the market when it is offered and that way it wouldn’t compete with investors too much. But for this to happen there would need to be a surfeit of supply. 

Yet, in reality, because of the ECB’s other policy measures, that is not going to happen.   

The fact is covered bond supply is going to be diminished by the ECB’s Targeted Longer-Term Refinancing Operation — which was recently made even more favourable to banks. 

Those lenders also have another bigger priority: meeting their regulatory funding ratios. Covered bond funding is low down on the list. 

It comes as no surprise that the ECB maintains a pretence that it has freedom of choice, but in reality no one is fooled.