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ECB Staying Focused on the APP

17 February 2017 by Gary Kirk

The minutes from the January ECB monetary policy meeting, released yesterday, made for fairly dull reading although one passage did strike a chord of interest with us.

In the Governing Council’s discussion on monetary policy decision, members “considered the implementation of the APP (asset purchase programme) to be proceeding smoothly following the decisions taken in December to expand the universe of eligible assets”. It seems fairly normal that the committee give themselves a pat on the back, even though market practitioners know that the programme is struggling to maintain an equalised level of purchases across the Euro-system. The minutes then go on to note that “the enhancements to the securities lending program had been welcomed by market participants as overall use of the program, and especially of the cash collateral option, had increased, mitigating collateral scarcity around the end of the year”; this highlights that the ECB recognised that the APP had begun to run up against liquidity constraints and made some necessary adjustments. As such and against that background, the Governing Council mentioned that they should carefully monitor market developments and the use of the securities lending facilities, and “stand ready to make further adaptations, if needed”. We think this is a most interesting and subtle insertion in the minutes i.e. the Governing Council is recognising that under its current guise the APP may require tweaking to deliver the result initially hoped for when QE was introduced.

Benoit Coeure (Executive Board member of the ECB) then offered ‘choices’ that are open to the council, which seemed to hinge on the relative weights to be given to the different criteria and restrictions of the APP; with limiting deviations from the ECB’s capital key, it also underlined that limited and temporary deviations were possible and inevitable. Thus, it appears there is some room for a trade-off between relative deviations from the capital key across jurisdictions and limiting the extent of purchases below the DFR (deposit facility rate).  Effectively this allows the ECB to buy a slightly greater proportion of peripheral sovereign bonds, to effect greater convergence against the core sovereigns; something that needs to occur if there is ever to be a level playing field for borrowers across the whole Eurozone.

We wrote about the importance of the capital key back in January 2015 (The Mysterious Capital Key), before the ECB APP had started, and again in October of that year saying that deviations away from the capital key were an obvious option for the ECB, but it was at the time blocked by concerns from core EU members that it flirted too close to monetarising sovereign debt. It is certainly one way to help address the divergence of peripheral debt levels compared to the core; which remains one big factor that needs to be addressed if the EU’s transmission mechanism is to run efficiently. A hint that it now seems to be back on the agenda saw peripheral levels tighten yesterday (despite the current political uncertainties) with 10yr Italian, Spanish and Portuguese bonds all tightening around 10bps tighter versus Bunds yesterday, following the release of the minutes.

This is by no means clarification that changes to the capital key will be adopted by the ECB, but one worth watching as it will result in the outperformance of peripheral sovereigns and the associated domestic financials.

[Footnote : The ‘key’ is a defined amount based on the size of the member state in relation to the whole of the EU. It is a simple combination of the population and gross domestic product, each carrying equal weight. For example if a country has a population that is equal to 5% of the EU total and it has an economic output of 10% of the EU total, then its capital key would be 7.5% – i.e. it would contribute 7.5% of the total ECB capital requirement.]

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