The European Central Bank’s public sector bond purchases are sizeable and their pace may increase further. However, issue and issuer limits constrain their time horizon. For monetary easing to remain credible and powerful the purchase of uncovered bank bonds and corporate bonds may have to be considered.

Claeys, Grégory and Álvaro Leandro (2016), “The European Central Bank’s Quantitative Easing Programme: Limits and Risks”, Bruegel Policy Contribution, Issue 2016/04, February 2016.
http://bruegel.org/wp-content/uploads/2016/02/pc_2016_04.pdf

The below are excerpts from the paper. Headings, links and cursive text have been added. Some acronyms and technical terms have been replaced by simplified language.

The basics

“On 22 January 2015 the ECB announced a massive expansion of its asset purchase programme. To supplement the Asset-Backed Securities and Covered Bonds Purchase Programmes (ABSPP and CBPP3) launched in September 2014, the ECB introduced a new Public Sector Purchase Programme (PSPP) to buy sovereign bonds from euro-area governments and securities from European supranational institutions and national agencies”

“While total monthly purchases of asset-backed securities and covered bonds had previously amounted to approximatively EUR10 billion per month, the new purchases of sovereign bonds, supranational institutions, and agencies raised the figure to EUR60 billion per month, EUR44 billion of which was dedicated to purchases of government and national agency bonds (and this EUR44 billion was divided between euro-area countries according to each country’s capital subscription at the ECB). The purchases started on 9 March 2015 and were originally meant to last at least until September 2016.”

On the key points of the ECB asset purchase programs view post here.
On their estimated impact on credit spreads and term premia view post here.

“[Over the course of 2015] the bank has expanded the list of national agencies whose securities are eligible for the Public Sector Purchase Programme (PSPP);…it has added regional and local government bonds to the list of eligible assets; it has announced that the programme would continue…to March 2017 ‘or beyond, if necessary’; and it has declared its intention to reinvest the principal payments on the securities purchased.”

The limits

“The ECB Governing Council imposed limits to ensure ex ante that the ECB would not breach the prohibition of monetary financing…On top of the eligibility criteria (i.e. only debt securities with a remaining maturity between 2 and 30 years and with a yield above the deposit rate can be bought), the ECB’s Governing Council also decided to put in place a 25 percent issue limit and a 33 percent issuer limit on Eurosystem holdings. The 25 percent issue limit was imposed to prevent the ECB from having ‘a blocking minority in a debt restructuring involving collective action clauses’. This indicated that the ECB did not wish to be in a position in which it had the power to block a potential vote on the restructuring of ECB-held debt of a euro-area country, because not blocking such a restructuring would be interpreted as monetary financing of a member state.”

“The changes to the design of the programme announced during 2015 greatly expand the universe of purchasable assets… [the ECB] has changed the issue share limit, which was originally set at 25 percent, to 33 percent (at least for securities without collective action clauses)…However, the decision to reinvest the principal payments as bonds mature, by increasing the monthly monetary purchase after March 2017, would also lead to the limits being reached sooner…. In the end, because of the issue share limit, for a given set of securities there will always be a trade-off between larger monthly purchases and a prolonged programme….These limits will constrain the duration and size of the programme…especially if the ECB decides to increase its monthly purchases.”

“[The figures below] show our projections for the monthly purchases, by country [under current PSPP rules]…In the [less favourable] scenario the limits are reached roughly at the same time as [they would at the time the PSPP was launched]…despite the increase in eligible debt…because of the reinvestment of principals, which kicks in in March 2017. [In the more favourable scenario] the limits will be reached later…For example, while [for the original programme] purchases in Germany are heavily constrained after April 2017, this is not the case [in this scenario] until March 2018.”

ECB_QE01

The options

“The universe of purchasable debt securities needs to be expanded because of the ECB’s self-imposed limit on the proportion it can hold of a given debt issue (decided at the launch of the programme) and not so much because of the scarcity of debt securities.”

The Eurosystem could purchase senior well-rated uncovered bank bonds. While they are riskier than the covered bank bonds which are already being purchased under the CBPP3, the comprehensive assessment carried out by the ECB and national supervisors in 2014 and 2015 should theoretically ensure that euro-area banks are adequately capitalised and can smoothly absorb financial shocks. According to the ECB, there is currently more than EUR2 trillion of uncovered bank bonds which are eligible as ECB collateral.”

Another possibility would be for the Eurosystem to purchase corporate bonds, of which there are almost EUR1.5 trillion eligible for collateral purposes (although part of these are not euro-denominated, or are issued by corporates outside the euro area, in which case they should not be eligible).”

“A more radical change would be to move away from an allocation of asset purchases between countries based on the ECB capital keys… The first major country in which the limits will be reached is Germany, because the amounts purchased in each country are proportional to the country’s capital subscription to the Eurosystem, of which Germany is the largest, while there is proportionally much less outstanding debt in Germany than in Italy, for example.”