On Thursday the European Central Bank provided a few more details on its covered bond programme — the bank’s newest unconventional policy measure.
While buying back covered bonds is more analogous to Credit Easing than the more dramatic Quantitative Easing, it does pose some interesting questions for the Eurozone. One of the reasons the ECB shied away from QE was that it was unable to decide how to allocate government bond purchases to the Eurozone members without affecting cross-country spreads in yields and thereby creating varying financial conditions for its members — something in conflict with its founding treaty. While the €60bn planned for covered bond purchases is a relatively small amount, that same allocation problem appears to be emerging.
From JP Morgan’s Euro-area economist Greg X Fuzesi:
Trichet confirmed that the ECB would purchase €60bn of covered bonds. Purchases would be made both in the primary and secondary market, and would begin next month. The purchases would be carried out gradually and would only be completed by June 2010. This slow implementation reflects that they are not only trying to improve liquidity in the secondary market, but are also trying to reducing rollover/issuance risk in the primary market. The latter objective requires a more gradual approach. But, this also suggests that there is relatively little risk that the €60bn limit would be raised soon. Apart from more technical details about the ratings of eligible covered bonds, Trichet also confirmed that the assets can be backed by both private and public sector loan pools, although he was more quiet on the country allocation. It is therefore unclear whether purchases will be allocated according to country size or whether they would also reflect the degree of stress in different national covered bond markets.
That degree of stress, lest we forget, varies widely from country to country. And while larger countries like Germany may have been more than a little unwilling to increase the ECB’s CE in the first place — that doesn’t mean they won’t want to feed from the CE trough now. After all any inflationary-risks associated with the policy (of the kind Frau Merkel railed against earlier this week) will be felt across the Eurozone given the single-currency. At the same time weaker members of the monetary union — like Spain or Ireland — will doubtless be lobbying for a larger share of the CE benefit.
We suspect the distribution of the covered bond purchase is a not-so-small detail that the ECB has yet to work out. Good luck to ‘em.
Related links:
Merkel speaks out on loose ECB policy – FT
Covered bonds revived by ECB buying spree – FT
Why the ECB is a good bank with rubbish assets – FT Alphaville
QE-fishing in the Eurozone – FT Alphaville