Tag Archive for: Quantitative easing

Will the ECB taper off its Quantitative Easing programme?

| 23-10-2017 | Lionel Pavey |

On the 26th October the ECB will have their next meeting. One of the main topics will be regarding the current QE programme and a possible announcement over its extension into 2018. Currently the ECB has, after 2 ½ years of QE, purchased more than EUR 2 trillion of mainly Government bonds. At present their monthly purchases amount to roughly EUR 60 billion per month.

A poll organized by Reuters would seem to indicate that the monthly programme would be tapered down to EUR 30-50 billion per month and possibly last for another 6 to 12 months from the start of 2018. Inflation is expected to be around 1.5 per cent till at least the start of 2019 – below the ECB target of just below 2 per cent.

However, under the current rules that govern the QE progamme the upper limit on outstanding purchases is around EUR 2.5 trillion. Taking the existing monthly purchases through to the end of 2017, implies starting 2018 with a balance of at least EUR 2.2 trillion – leaving just EUR 300 billion of headroom for future purchases. If it cut monthly purchases in half, the scheme could be extend to the end of the 3rd quarter in 2018, but no further.

Can the ECB continue QE longer than expected?

The constraints imposed on QE mainly relate to the purchase of Government bonds – maximum 33 per cent of each countries outstanding debt and maximum 25 per cent of any bond issue. The provisions written into the Maastricht Treaty clearly state that the ECB may not finance member states. QE also purchases non-bank bonds (covered bonds, corporate bonds and asset backed securities) which are subject to different criteria – maximum of 70 per cent of any bond issue.
At present, the ECB only holds about 13 per cent of the eligible bonds leaving a large headroom for future possible purchases.

It is conceivable that the ECB could reduce its purchase of Government bonds and simultaneously increase its purchase of corporate bonds, thereby maintaining liquidity to its QE programme. The major drawback is that it would reduce the amount of freely tradable corporate bonds in circulation and have an effect on their price.

What does this mean for interest rates?

As long term debt instruments use Government bond yields as the basis for calculating their yield, when the ECB stops buying Government bonds, the yields on all other debt instruments will increase. At the moment the benchmark (German 10 year Government bonds) yield around 0.4 per cent per annum and the 10 year Interest Rate Swap yields around 0.9 per cent per annum. In 2014 (the year before QE started) German yields averaged 1.25 per cent even though they were in a downward trend the whole year. Assuming the yield spread between Government bonds and Interest Rate Swaps (IRS) remained constant, this implies 10 year IRS moving to at least 1.75 per cent. This would still be below the long term average since the inception of the EURO in 1999 that stands around 3.35 per cent, but a significant increase from the current level of 0.9 per cent.

What happens when the next crisis arrives?

The ECB is not the only central bank to use a form of QE. The Fed, Bank of England and Bank of Japan all have their own versions. When these countries also taper out their QE, naturally there will be a corresponding rise in interest rates. However, if a new financial crisis was suddenly to happen (not unthinkable at the moment) all 3 of these central banks can reapply QE to stimulate their economies. An additional increase to their balance sheets can be accommodated.

Unfortunately for the ECB the very criteria that now applies would make it impossible to restart QE. The ECB could not just increase its balance sheet – current criteria and regulation make that impossible. Any attempt to change the rules would be met by objections from national governments within the EU and legal action. The Bundesbank were very vocal in their objections to the implementation of QE in 2015 – those protests will not have softened by now.

This shows the constraints prevalent upon the EURO – monetary policy is the only tool that the ECB has at its disposal. One policy can not be used to fix all the problems present with the economies of all member states.

 

 

Lionel Pavey

Cash Management and Treasury Specialist

 

The end of the Euro as we know it – when the party ends?

| 4-5-2017 | Lionel Pavey |

 

The papers are full of stories about the level of Government debt within the Eurozone (Italy has a debt to GDP ratio of more than 130%), probable new bailouts for Greece, lack of suitable bonds to purchase for Quantitive Easing, Brexit, the rise of populist rightwing politics etc. Well at least we have all the bad news out in the open – don’t we?

Target 2

A new problem has arisen that was partly accelerated by QE – namely the outstanding national balances within Target 2. This is the “Trans European Automated Real-time Settlement Express Transfer System” foe the Eurozone. The key word is “Settlement” as I shall explain.
When a financial transaction is agreed 2 actions have to happen – clearing and settlement. Clearing entails all the actions that must be undertaken up to settlement, such as delivery of bonds, securities or shares. Settlement means the exchange (transfer) of money for goods or bonds etc.

When a party in Italy buys goods from the Netherlands, they instruct their bank to debit their account and credit the account of the seller. This is a cross-border transaction. But, within the Eurozone monetary settlement does immediately take place between banks. The Italian bank will have its balance reduced at the Banca D’Italia and the Dutch bank will have its balance credited at de Nederlandsche Bank. However, the balance is not settled between the 2 central banks – a new claim is shown on their books.

At the end of 2016, according to the Euro statistics website Italy has a negative Target 2 balance of EUR 420 billion with other countries in the Eurozone. This amount has been accumulated over the years since 1999 and now represents more than 25% of GDP. This is on top of the Italian Government debt of 130% of GDP. If a country were to leave the Eurozone they would be liable to immediately settle their Target 2 balances – something that is not realistic. Under the current agreement the other countries within the Eurozone would be liable to cover the debt. Target 2 balances do not have to be settled as countries would never default appears to be the thinking.

At the other end of the scale, Germany has an outstanding claim on other Eurozone countries of EUR 830 billion. At the moment these amounts are shown at full face value in the books – it would appear that politically, no one wants to acknowledge that the claims can not be settled in full under the current constraints within the Eurozone. If the Eurozone are 100% committed to supporting the Euro and, the balances are not going to be settled within the foreseeable future then, eventually, something will have to break.

Emperor with no clothes

Confession time – I am English (and proud of it). If I had been able to vote in last year’s referendum in the UK, then I would also have voted for Brexit. This does not make me anti-European; rather the reality of the Eurozone is very much like the fable of the Emperor with no clothes. Everyone sees it, but no one will say it. Perhaps, a solution can be found that does not mean debt forgiveness, writedowns, defaults or exits, but common sense would imply that this is wishful thinking.

When I was a young boy at Grammar School I had to learn some poetry for my English Literature exam – it included D.H. Lawrence. As a wild youth I could cope with Shakespeare, had a hard time with Chaucer, but fell in love with a poem by Lawrence entitled “A Sane Revolution”. He told us to make a revolution for fun and not in seriousness. Also I knew the poem as it was quoted by Mott the Hoople who got me through my teenage years with their music.

The creation of the Euro is a revolution in European history, but could it ever be called sane?

TARGET 2 BALANCES

Source: http://sdw.ecb.europa.eu/reports.do?node=1000004859

 

GOVERNMENT DEBT

Source: http://www.debtclocks.eu/select-an-eu-member-state.html

Lionel Pavey

 

Lionel Pavey

Cash Management and Treasury Specialist

 

Lionel Pavey about the German Bund Yield. Is there a solution?

| 17-06-2016 | Lionel Pavey |

This week’s headlines were all about the German Bund Yield hitting a historic low. On Wednesday we also published an article about this subject and asked our experts to respond. Expert Lionel Pavey reacts with a full article on the German Bund Yield and asks himself; is there a solution?

Possible reasons:

  • Flight to quality – investors looking to place their money in a safe place
  • Brexit referendum – polls suggest chance of exit greater than ever leading to uncertainty
  • Quantitative easing – ECB policy of buying government bonds pushes bond prices up and decreases the yield

Since 2008 governments have attempted to kickstart their economies using monetary policy – lower rates and quantitative easing. The sellers of government bonds who receive cash do not appear to be either spending it or investing it – a report from Merrill Lynch states that fund managers are sitting on more cash than at any times since 2001 and have reduced their shareholdings to their lowest level in 4 years.

It would appear that all efforts by central banks via monetary policy have not succeeded. If government yield are persistently negative there is a possibility of stagflation and important investment decisions being deferred to a future date, leading to falling prices and a vicious downward spiral.

Is there a solution?

When I studied economics there were 2 schools of thought at the time – Milton Friedman and John Maynard Keynes. I have always felt that Keynes was discarded rather harshly by the monetarists.

Keynes stated that in recessions the aggregate demand of economies falls. In other words, businesses and people tighten their belts and spend less money. Lower spending results in demand falling further and a vicious circle ensues of job losses and further falls in spending. Keynes’s solution to the problem was that governments should borrow money and boost demand by pushing the money into the economy. Once the economy recovered, and was expanding again, governments should pay back the loans.

It is that last sentence that is pertinent. Keynes’ remedy runs countercyclical to the business cycle –instead of using all the money to buy up Government Debt, Government should borrow the money directly and embark on large projects to improve the infrastructure within a country. When the economy was revived Government should then repay the money borrowed and run a budget surplus.

 

Lionel Pavey

 

Lionel Pavey

Cash Management and Treasury Specialist – Flex Treasurer