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ECB becomes a price taker

This week the ECB scaled back buying in the primary covered bond market and gave the private sector a chance to set the price.

Instead of being the majority investor that it has been in the previous handful of deals, it became the minority buyer of a €1bn seven year Italian issue from Cariparma. This important change in the bank's strategy will help resuscitate the moribund market, as issuers will be once again be able to sell deals to a broad range of investors, instead of opportunistically relying on ultra-cheap funding from the behemoth central bank.

Last week, OP Mortgage Bank only just managed to get a deal away, AIB Mortgage Bank had to pull one, while Helaba and WL Bank sold nearly two thirds of their deals to the euro system. It was no coincidence that these deals and others issued by borrowers in France and Belgium were all priced at record tight levels. But the spread on these trades was so tight that the majority of covered bonds investors — established buyers that have traditionally provided the bulk of covered bond demand — did not take part.

Wholesale funding is never purely about achieving the lowest cost. It is also about trying to keep up funding relationships with differentiated pools of investors throughout the world. It is no coincidence that the five deals that were priced up to the end of last week had on average fewer than 50 investors compared with more than 100 for the first five deals of the year. But at that time, another covered bond purchase programme seemed impossible.

However, after nearly drowning the market, the cycle is starting to turn, and it seems the ECB is now doing what it vowed to do at the beginning and avoid aggressively dragging the market tighter. This week, it purchased 35% of the Italian deal with an order that came in late and well after the private sector had had ample opportunity to set the price.

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