What’s the hard limit to ECB hard money? | FT Alphaville

What’s the hard limit to ECB hard money?

Well, it’s the ECB’s own and apparently limitless obsession with inflation, of course. Also it’s Article 123 of the EU Treaty:

Though if you’re asking about sterilising purchases of debt, as a technical limit to the central bank’s printing euros, to monetise government bonds, to resuscitate the eurozone…

Here is an interesting answer.

Though first here’s the problem:

Many wish the ECB would intervene in bond markets like this:

(H/T Macro Man) When in fact the situation is this:

The ECB is the dam. The central bank is not stemming the selling of Italian bonds (notably by banks) which is helping to drive yields up, and potentially into a death spiral at these levels.

But also the bank is buying in dribs and drabs relative to the flows of sellers out of these bonds, and to the stock of Italy’s €1,900bn debt. Even the €10bn bought in the last week is not a big, market-awing load. It’s partly because the ECB has to sterilise the bond purchases. It comes to banks every week to issue them with seven-day deposits which are equal to the amount of all sovereign bonds bought so far (currently around €184bn), mopping up liquidity from buying and holding the bonds.

Which makes a calculation by Rabobank on Tuesday of when the sterilisation operations can technically no longer contain liquidity created by large amounts of bond-buying, highly interesting.

As Rabobank’s analyst Elwin de Groot argued (click to expand the charts):

In the near-term, there seems ample room for more sterilization, simply because the eurozone banking system has borrowed large amounts from the ECB (made easy by the ECB’s policy of full allotment at the going refi rate), which they have been more than willing to place back at the ECB…

End-October, banks had borrowed EUR587bn from the ECB. However, in view of the long-term character of the bond purchases, it would be a more prudent approach to look at the ‘permanent’ level of ECB lending to the banking system. This is the amount that banks need for maintaining their regular operations and reserve requirements, which should be held in their current accounts at the ECB.

With structural ECB monetary policy lending approximately EUR450-500bn (based on pre-crisis levels) and reserve requirements of about EUR200bn, we argue that the amount left for structural sterilization is in the range of 250-300bn. Natural optimists, we take the 300bn as a starting point. Confronting this with the current amount of bonds the ECB has purchased (around 184bn), there is some EUR116bn left. This, in our opinion, should be relatively easy to sterilize, also from a longer-term perspective.

Simply put, anything beyond the 300bn limit in bond purchases, would structurally raise the ECB’s liabilities to eurozone credit institutions above the normal amount of borrowing by these credit institutions and would thus prove harder to sterilize, as the ECB’s deposit tenders would have to compete with other investment opportunities. Of course, in times of uncertainty, that may not be a big deal (banks have already been ‘parking’ large amounts on the ECB’s overnight facility), but the ECB is likely to keep a long-term perspective here. It will also have to retain the possibility to stop its policy of full allotment at any point in time, however unlikely that may seem right now.

Based on current buying rates, the limit would be reached in early 2012, Rabobank say.

After that, the ECB goes unsterilised and does QE, or… stops.

The €300bn ‘limit’ is interesting because if you take it for granted that the ECB is ‘usually’ prepared to buy 20 per cent of a government’s bonds (which it has done in Greece, Portugal, and Ireland), the ECB would reach the sterilisation limit before it could ever come close to owning 20 per cent (€380bn) of Italy’s outstanding debt.

As for the technical aspects of sterilisation — you could take the Rabobank calculations on bank borrowings as a sign that the ECB could carry on sterilising for a long time. Banks are likely to keep parking cash at the central bank for as long as the sovereign debt crisis closes markets. The ECB could also keep its deposits as an “attractive” investment by giving them a longer maturity, such as issuing debt certificates.

But the overall problem is still there. Rabobank title their report “When does the ECB go nuclear?” though it’s maybe more “When’s the last moment for the ECB to decide whether to go nuclear?”. To many market participants, the question can be changed again to “When does the ECB do the inevitable?”.

Of course, if you do believe that the crisis will be solved with the ECB monetising debt, you probably think the central bank won’t wait for sterilisation to putter out in 2012. A meltdown in Italy would drive them there sooner.


Italy is melting down. ECB board members come out every day to insist that price stability and an independent monetary policy are paramount. You, and we, might think it’s blinkered but that is their operational code, quite simply.

In short, there’s still every sign they’ll stop before un-sterilising.

Related link:
The ECB is not here to save the world – FT Alphaville