Sterilised and scandalised | FT Alphaville

Sterilised and scandalised

FT Alphaville mentioned last week that the sterilisation or non-sterilisation of the European Central Bank’s government bond-buying was likely to be an extremely controversial move.

We weren’t wrong.

The ECB announced on Monday that it will sterilise its €16.5bn of bond purchases via the auction of one-week fixed-term deposits. Banks will be able to bid for the deposits, and they’ll be given to those that bid at the lowest yields. The first auction is scheduled to be held today, Tuesday.

But here’s the key bit from the ECB’s statement:

Fixed term deposits held with the Eurosystem are eligible as collateral for the Eurosystem’s credit operations.

Which means the ECB’s govt bond purchases will be offset for a full week — until the banks can repo the fixed term deposits at things like the Long-Term Refinancing Operation (LTRO). What liquidity the ECB takes away with one hand, via the term deposits, it gives in unlimited amounts with the other.

Anyway, some analysts are (predictably) criticising the move — mostly on the grounds that it is largely symbolic, with little meaning so long as the ECB’s other liquidity ops are running at full speed.

Julian Callow over at Barclays Capital has some of the more nuanced commentary:

In our view, given recent comments by officials, this announcement is not a surprise and is intended as a rapid response to assuage concerns in some quarters (such as in parts of the German media) that the purchase of government bonds could be a form of quantitative easing resulting in greater inflationary risks. That said, the ECB is not in control of the monetary base and excess liquidity ends up back at the ECB via the deposit facility, and so this announcement is intended more for “presentational” purposes, to assuage inflation concerns. Bearing in mind that the excess liquidity of the banking sector is around EUR320bn, today’s announcement serves to underline that the ECB has not been engaging in a substantial form of quantitative easing with its government bond purchases (rather, the purchases were intended to “address the malfunctioning of securities markets and [to] restore an appropriate monetary policy transmission mechanism”).

His sentiment was echoed last week by Gilles Moec at Deutsche Bank:

The ECB has stated that it would “sterilize” its purchases of government paper. This is normally done by offsetting the additional liquidity created by the purchases of peripheral government bonds by selling other assets. However, sterilization would collide with the reinstatement of the LTROs at full allotment, which implies that the central bank won’t be in position to control the overall level of liquidity in the financial system. The ECB will probably have to wait until the exceptional LTROs finally unwind, which will take place at the end of 2010, to readjust liquidity to its desired level. Actually, it may well be that improved perceptions as to the state of the financial system in Euroland result in a spontaneous fall in the demand for liquidity. Still, the ECB is probably going to be criticized for putting its balance sheet at risk and failing to resist national governments’ demands.

While JP Morgan’s David Mackie has the harshest critique. Writing after the announcement:

We have argued that the ECB’s intention to sterilise the outright bond purchases was largely symbolic, given the massive excess reserves being created by the regular unlimited tender operations. The symbolism was nevertheless appealing in order to signal the exceptional and temporary nature of these controversial outright purchases. In the event, there was less symbolism than we expected . . . in terms of a sterilisation operation, two features are striking. First, the term of the fixed-term deposit is only one week. And, second, the fixed-term deposits will be eligible as collateral in the ECB’s regular tender operations. It is hard to see how this amounts to sterilisation as we would define it, and it is hard to see any symbolism in this move.

And writing just 40 minutes before the announcement, he had this (even harsher stuff) to say:

Since the ECB’s decision to begin outright debt purchases, President Trichet has argued repeatedly that the central bank is not engaging in the kind of quantitative easing that the Bank of England and the Federal Reserve have engaged in over the past eighteen months. He’s right, it’s not: what the ECB is doing is potentially far more worrying. The ECB is now purchasing the government debt of sovereigns whose solvency is in question: neither the Bank of England nor the Federal Reserve did that . . . the impact of the outright purchases will be sterilised, likely by the auction of term deposits. Last week, we highlighted that the commitment to sterilise the outright purchases was largely symbolic in the light of the unlimited liquidity provision of the regular tenders. Another point we would stress regarding sterilisation is that the transmission mechanism from monetisation to inflation comes more through a rise in velocity, driven by a decline in people’s faith in the currency, rather than an increase in the money supply per se. For example, in the first half of 1921, Germany was experiencing outright deflation; by the second half of that year it was experiencing an annualised inflation rate of over 500%. This move in inflation was not driven by a sharp increase in the pace of monetisation by the Reichsbank, but rather by a huge move up in velocity driven by higher inflation expectations. This puts [ECB executive board member Alex] Weber’s comments of two weeks ago into the right context. In explaining why he felt that limiting contagion did not justify using “every means”, Weber said that “measures that damage the fundamental principles of the currency union and the trust of the people would be mistaken and more expensive for the economy in the longer term.”

Ouch David. Tell the ECB what you really think…

Related links:
The slippery slope to non-sterilisation
– FT Alphaville
Europe’s QE is sterilised and sensitive – FT Alphaville
XXL liquidity and a side of inflation, says MOST – FT Alphaville
Why the ECB is a good bank with rubbish assets – FT Alphaville