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The New World Ordoliberalism Part 6: The QE Taper Caper and the Portuguese Squeeze

With 2017 set to be a year of critical elections for eurozone – including federal elections in Germany, the Netherlands, and France [1] with the potential to reshape the eurozone – and since these elections are probably going to be heavily shaped by the ongoing existential freak out the eurozone’s wealthier nations’ role in the eurozone in relation to the seemingly endless eurozone crisis, 2017 is probably going to be an especially good year to point out that problems with the eurozone’s existing structure don’t include a problem with a eurozone disproportionately harming those wealthier members. The problem is quite the opposite: the eurozone is designed to help those wealthier members at the expense of its poorer fellow members.

And it’s set up to do this in a myriad of different ways, most obviously the systematic devaluation of the currencies of stronger economies coupled with the systematic increase in the currencies of weaker eurozone members. But, as we’ve seen with so many times of the “bailout” in the past, the “bailouts” themselves are also one of the many way the eurozone is designed, or evolved on the fly, to benefit the strong over the weak, often under the spirit of “no one member can benefit more than the others”. The eurozone is a strange construct if you haven’t noticed.

And in this particular chapter of our exploration of what’s wrong with the eurozone we’re going to take a look at the evolving nature of the European Central Bank’s (ECB’s) quantitative easing (QE) program. Specifically, how the QE program was facing a set of obstacles that was going to require some tweaking to the program and how the solution to the obstacle was to basically choose the tweaks that harmed the weak, in particular Portugal. In favor of Germany, of course. Keep in mind that Portugal recently formed a left-wing anti-austerity government and has done relatively economically well since coming into power [2]. Also keep in mind that Portugal is one of the few eurozone nations not facing a rising far-right “populist” movement as a response to its harsh austerity program [3]. So you might say the timing is “right” for some preferential treatment of Portugal. Preferentially bad treatment.

First, let’s take a look at the situation back in August, before these tweaks were put in place: The ECB was facing a QE conundrum. The QE rules state that the ECB can only buy eurozone government bonds under the following criteria (self-imposed criteria that the ECB created for itself earlier):
1. The total bond purchases for a given country can’t exceed 33 percent of its sovereign total bond market.

2. The bonds purchased cannot bear interest less than -0.4 percent.

3. Due to fears of QE becoming a backdoor bailout for the crisis-ridden countries, all bond purchases must follow a “capital key” that caps the maximum bonds that can be purchased in a given European country according to the size of that country’s financial system. In other words, all countries participating in the ECB’s QE program (all eurozone countries plus some others like the UK), would get equal stimulus, relative to the size of their economies and regardless of the need, or lack thereof, for the QE program.

Those were the rules. And by August, almost half the eurozone sovereign bond market was held by the ECB (no one said cleaning up a historic financial crisis would be quick or casual) and a significant problem was emerging: Germany was running out of bonds that were yielding above -0.4 percent. So if the QE program was going to continue without breaking the rules one or more of those three rules was going to have to be modified [4]:

The Financial Times
Fast FT

ECB set to run out of bonds to buy – Credit Agricole

August 16, 2016

by: Mehreen Khan

Liquidity, liquidity everywhere and not a bond to drink.

In a world of record negative yielding sovereign bonds and ever-increasing doses of quantitative easing, the European Central Bank’s bond-buying blitz could soon hit the buffers.

The central bank’s €80bn-a-month debt spree will have hoovered up half the entire universe of eligible government debt by the end of the year, according to analysis from Credit Agricole, writes Mehreen Khan.

With the ECB scrambling around for paper, more than two-thirds of the sovereign bond market that qualifies for QE will be on the ECB’s balance sheet by next September they predict, leaving policymakers scratching their heads over how to extend stimulus measures.

And the scarcity problem is primarily German. According to its own QE criteria, the ECB is now excluded from buying Bunds with a maturity under seven years, as they have fallen below the -0.4 per cent yield floor set by the central bank. That’s around 40 per cent of the entire German bond market, or €413bn according to figures compiled by Tradeweb.

Germany matters. It is the largest economy in the eurozone and thus makes up the single biggest proportion of the capital key set out by the ECB for its total purchases.

“If the ECB cannot purchase German bonds, then it will have to change the modalities of its purchases”, says Louis Harreau at Credit Agricole.

“Germany’s share in the ECB’s capital is too big to be compensated by substitute purchases” he notes.

Analysts widely expect the central bank to tweak the terms of its stimulus programme to broaden the universe of eligible debt and ease the bond-supply bottleneck.

This can be done in three ways: by cutting the ECB’s deposit rate below -0.4 per cent; increasing the ceiling on its “issuer limit” from 33 per cent; and by shifting around with a “capital key”, where purchases correspond to a member states’ proportion of overall eurozone GDP.

Mario Draghi, ECB president, has promised “flexibility” to ensure the central bank continues to hits its monthly purchase target. But as ever in the eurozone, politics is set to throw sand in the wheels of any swift changes to the stimulus programme, which was first launched in March 2015.

Jens Weidmann, the uber-hawkish president of the Bundesbank and ECB board member, has cautioned against ramping up purchases from the indebted countries of the south as it would threaten the ECB’s cherished independence.

If “we focus more particularly on highly indebted countries, we blur the boundaries between monetary policy and fiscal policy which continues”, Mr Weidmann said earlier this month. [5]

But removing political barriers to action would not prove a panacea if the ECB wants to keep the monetary taps on past a notional September 2017 end date, notes Mr Harreau.

He calculates that removing the deposit rate “will not be enough to alleviate the scarcity concerns” around German, Finnish, Dutch and Spanish bonds should QE continue after September 2017.

So what’s the best way to keep buying time?

The most effective option is also the boldest: dropping the capital key – where larger economies make up the biggest proportion of the monthly purchases. This would likely skew QE towards smaller economies, allow the ECB to continue snapping up bonds from Portugal and Ireland (former bailout countries), and “remove downward pressure on core yields”, adds Mr Louis.

But it’s also the option that will be most politically unpalatable for the larger northern creditor states of the eurozone.

All in all, the best solution to the ECB’s woes is one that would make the very necessity of QE pretty redundant – a growing economy, rising bond yields, and a natural increase in the universe of eligible debt.

Chicken and egg.

“The most effective option is also the boldest: dropping the capital key – where larger economies make up the biggest proportion of the monthly purchases. This would likely skew QE towards smaller economies, allow the ECB to continue snapping up bonds from Portugal and Ireland (former bailout countries), and “remove downward pressure on core yields”, adds Mr Louis.”

So back in August, it was clear something had to be done to allow the ECB’s QE program to proceed without running out of bonds. And it was also pretty clear to observers that the most effective way to tweak the rules would be to drop the “capital key” rule so the ECB can focus its bond purchases on the countries that need it most while avoiding the purchases of bonds in countries like Germany where bonds are already in negative territory. This was seen as the option that would be the most helpful for the eurozone as a whole, much more so than the other options like lowering the minimum “deposit rate” yield on the ECB’s purchased bonds below -0.40 percent which would simply allow the ECB to find more eligible German bonds (since so many of them are already yielding below -0.40 percent) to keep the QE program going.

Portugal (and Ireland) Approach the Limit and Preemptively Deviate From the Capital Key in Response

But also note that Germany wasn’t the only country running out of space to operate in the QE program, something that was obvious earlier in the year. As early as April, Portugal and Ireland were facing a different kind of problem and dropping the “capital key” wasn’t going to fix it. At least not alone. That’s because Ireland and Portugal were already on track to exceed the ECB’s 33 percent cap on the total volume of bonds held for a given nation before the QE program was set to expire in March of 2017 due to the fact that the ECB still has bonds from Portugal and Ireland leftover from its 2010-2012 “Securities Markets Programme” [6] (the first of the eurozone crisis emergency responses). And as a result, the ECB’s QE bond purchases were already deviating from the “capital key” for Portugal and Ireland. And not in a helpful way [7]:

Reuters

Wary of hitting limits, ECB holds back on Portuguese, Irish bond buys – sources

By Balazs Koranyi and John Geddie | FRANKFURT/LONDON
Tue May 17, 2016 | 9:20am BST

The ECB limited its sovereign debt buys of Portuguese and Irish bonds last month due to concerns about hitting its purchase caps, central banking sources said, in a move that could mean those countries stand to benefit less from the scheme.

With almost a year left of its quantitative easing programme, the ECB is already nearing a self-imposed limit of holding a third of the countries’ debt due to the large amounts of bonds it bought under previous crisis-fighting measures.

This became an issue when the ECB increased its monthly asset buys to 80 billion euros in April from 60 billion euros. Data shows that so far purchases have increased by more than 50 percent in most euro zone countries but only by 16 percent in Portugal and 33 percent in Ireland.

Two sources familiar with the situation said the ECB and national central banks that conduct the buying had supplemented Portuguese and Irish bonds with the debt of supranationals to avoid having to curtail buying of their debt more radically or even having to cut them off completely once it hits its limits.

The curtailed buying means that the ECB’s sovereign debt purchases will deviate slightly from the countries’ shareholding in the central bank, called the capital key, possibly muting the positive market impact of the scheme in Portugal and Ireland.

While QE has pushed borrowing costs in the euro zone to record lows in many countries, some investors say that uneven purchases of sovereign debt could mean vulnerable countries like Portugal do not benefit as much as the bloc’s largest economy, Germany, thereby escalating political tension in the region.

“If the ECB is going to target purchases on some sovereigns at the expense of other sovereigns, then effectively you have got an unequal application of that monetary policy,” said Mark Dowding, a portfolio manager at BlueBay Asset Management.

“In extremis, you are saying that this is going away from a trend where you are trying to bring Europe together, and it is looking more like something that could push Europe apart.”

LEFTOVERS

The sources said the ECB was keen to keep both countries in the programme until the projected end of the scheme in March 2017, but said that the buying could still fluctuate over time and that the ECB also reviews its issuer limit every six months.

Left over from its Securities Markets Programme, a scheme launched in 2010 to tackle an escalating debt crisis, the ECB held 9.7 billion euros of Irish debt at the start of 2016 while its Portuguese holdings stood at 12.4 billion euros. Since the start of QE, the ECB has bought 11 billion euros of Irish debt and 16.2 billion in Portugal.

The ECB’s issuer limit also suggests that if Greece joins the programme, ECB purchases will be severely curtailed as the bank is already one of the bigger holders of Greek debt.

The ECB has already stopped purchases in Cyprus because the country does not have the necessary credit rating and keeps sovereign buys limited in several countries, like Estonia, for liquidity reasons.

“This became an issue when the ECB increased its monthly asset buys to 80 billion euros in April from 60 billion euros. Data shows that so far purchases have increased by more than 50 percent in most euro zone countries but only by 16 percent in Portugal and 33 percent in Ireland.

That was the situation back in May, shortly after the ECB expanded its monthly QE bond purchases from 60 billion to 80 billion euros a month. Most of the eurozone countries saw a 50 percent increase in bond purchases but Ireland and Portugal, two of the countries that the QE program was intended to help, were forced to undershoot the increase relative to what the “capital key” would have called for.

But that was far from the only economic warning sign flashing for Portugal at the time. As the article below points out, Portugal is just one credit ratings downgrade away from getting kicked out of the ECB’s QE program entirely. And if that happens, Portugal will face a dilemma that’s now painfully familiar for the eurozone: leave, or undergo another round of “bailouts” (brutal austerity) with the hopes of reentering the QE program later [8]:

The Wall Street Journal

Portugal’s Financial Independence Hangs by a Thread
Country’s access to ECB bond-buying program depends on debt rating by Canadian firm DBRS

By Patricia Kowsmann
April 29, 2016 12:30 a.m. ET

LISBON—Nearly two years after Portugal left a €78 billion ($88 billion) international bailout program [9], its financial independence continues to hang by a thread.

That thread is a little-known Canadian firm, DBRS Ltd., the only rating company that maintains an investment-grade rating on Portuguese debt. That rating gives Portugal access to the European Central Bank’s bond-buying program, which has kept bond yields low and relatively stable despite recent global market turmoil, a December bank failure [10] and friction between European Union officials [11] and the country’s new government over its budget plans.

On Friday, DBRS will announce the result of its twice-yearly review of Portugal. A downgrade to junk status—the rating the country gets from Standard & Poor’s, Moody’s Investors Service and Fitch Ratings—would force it out of the ECB program and raise borrowing costs for its government, banks and companies.

That, in turn, could reawaken fears over Portugal’s future in the eurozone and the sustainability of the bloc itself, which is struggling to manage Greece’s fiscal troubles. Portugal would be required to take a new bailout to get a chance to re-enter the ECB program.

“The fact that the country’s future in sovereign debt markets hinges upon a single decision shows that Portugal is still in a very delicate situation,” said Antonio Barroso, an analyst at political-risk consultancy Teneo Intelligence. “It is also a reminder for politicians both in Lisbon and in Brussels that they should be doing more in order to prevent a return of the crisis to the eurozone.”

During its three-year bailout program, which ended in May 2014, Portugal was considered an exemplary follower of the Germany-led austerity model. The center-right government at the time, led by Prime Minister Pedro Passos Coelho, cut public employees’ wages, raised taxes and slashed spending to balance its accounts. The budget deficit fell sharply, from close to 10% of gross domestic product in 2010 to 3% of GDP last year, excluding a capital injection into a failed lender.

Mr. Passos Coelho privatized state companies and changed labor regulations to bring down labor costs and make exports more competitive.

Still, Portugal’s economy struggles. Exports are rising, but so are imports. Investments remain scarce. Unemployment exceeds 12%.

The International Monetary Fund predicted recently that Portugal’s economy would grow an average of 1.3% a year over the next six years, too slowly to reduce a debt burden that stands at 129% of GDP.

Portugal’s perception among investors has been hit by two bank failures since 2014 and the election of a Socialist-led government that has raised the minimum wage and promised to raise public-sector wages and lower taxes.

Socialist Prime Minister António Costa, who took office late last year with the backing of three far-left parties, has softened his rhetorical attack on his predecessor’s austerity measures. He has agreed to make deeper budget cuts this year to avoid a fight with the European Commission.

Even if it manages to avoid a downgrade now, pressure on Portugal is expected to grow.

DBRS has cited a global economic slowdown, debt sustainability and a rise in bond yields as factors to watch.

As he cuts the budget, Mr. Costa could be forced to choose between alienating his far-left allies in parliament or confronting the European Commission and its fiscal rules.

“The biggest concern that we would have would be [an] open conflict with the European Commission,” Fergus McCormick, head sovereign analyst at DBRS, said in February.

During its three-year bailout program, which ended in May 2014, Portugal was considered an exemplary follower of the Germany-led austerity model. The center-right government at the time, led by Prime Minister Pedro Passos Coelho, cut public employees’ wages, raised taxes and slashed spending to balance its accounts. The budget deficit fell sharply, from close to 10% of gross domestic product in 2010 to 3% of GDP last year, excluding a capital injection into a failed lender.”

And despite being considered an exemplary follower of Germany-led austerity, Portugal’s economy is still so fragile that a single credit rating downgrade could kick it out of the ECB’s QE program…a program designed to help the eurozone’s weakest economies. Isn’t the eurozone fun?

Fortunately for Portugal, DBRS – the last credit rating agency left in the world that gives Portugal’s debt an investment grade rating – did reaffirm Portugals credit rating back in April. And did so again in October [12]. So, for now, Portugal is still able to participate in the QE program that is vital to its economic recovery. But just barely.

And as we saw above, there’s still the issue of less Portuguese bonds being bought under the QE program than the “capital key” warrants due to concerns over the country hitting that 33 percent cap before the QE program finally winds down. So even if ECB extends the QE program past its March 2017 deadline, the question of how Portugal would get around these barriers remained.

The ECB’s Disappointing September. And Terrifying Taper Talk in October

And what did the ECB eventually decide to do with Germany running out of eligible bonds and countries like Portugal and Ireland hitting their 33 percent cap? Well, also keep in mind that the current round of the ECB’s QE program is scheduled to expire in March of 2017. So with a number of eurozone economies still in dangerously fragile territory the expectation back in September was that, at a minimum, the ECB was going to announce an extension of its QE program past March 2017 during is meeting on September 8th. And, or course, that didn’t happen, despite a cut in the estimated economic growth forecast [13]:

CNBC

ECB surprises by failing to extend QE deadline; cuts euro zone growth forecasts

Katy Barnato
Thursday, 8 Sep 2016 | 9:06 AM ET

The European Central Bank (ECB) surprised markets on Thursday by failing to extend the deadline for its trillion-euro bond-buying program.

Expectations were high the central bank would prolonging the program beyond its current deadline of March 2017, but it did not do so.

The euro zone STOXX 50 index fell on the news, but the euro rose slightly against the U.S. dollar to near a two-week high. The yields on German benchmark 10-year Bunds turned slightly less negative.

ECB President Mario Draghi said the central bank did not discuss extending the program at its latest monetary policy meeting.

“Our program is effective and we should focus on its implementation,” he said at his regular post-decision media conference on Thursday.

The ECB held its key interest rates unchanged on Thursday, as expected. The rate on the ECB’s marginal lending facility stands at 0.25 percent, with the rate on the deposit facility at -0.4 percent. The fixed rate on the ECB’s main refinancing operations remains at zero. The ECB last moved rates in March, when it cut the rate on the marginal lending facility by 5 basis points.

Despite the ECB’s monetary stimulus program – which includes low or negative rates, low-interest loans to banks and a trillion-euro bond-buying program – the euro zone’s economic growth and inflation rate remain stubbornly low.

On Thursday, the central bank raised its economic growth outlook for the euro zone slightly for 2016, but cut it for 2017 and 2018. It now sees growth in the 19-country bloc averaging 1.7 percent this year, having previously forecast 1.6 percent growth. It forecasts expansion of 1.6 percent in 2017 and 2018, down from its June forecast of 1.7 percent in both years.

The central bank’s 2016 inflation forecast was held at 0.2 percent and its 2018 estimate stayed at 1.6 percent. However, it cut its 2017 forecast to 1.2 percent from 1.3 percent.

“We will preserve the very substantial amount of monetary support that is embedded in our staff projections and that is necessary to secure a return to inflation,” Draghi said in his statement.

Draghi said the ECB’s monetary stimulus would boost euro zone economic growth by 0.6 percent over the forecast horizon and inflation by 0.4 percent.

The euro zone’s economy is seen being hampered by sluggish global demand, due to several factors, including the U.K.’s vote in June to quit the European Union, he added.

The ECB’s inflation forecasts are particularly important, as the central bank has a single mandate to target price stability. It aims for inflation of close to, but below 2 percent over the medium term. Average inflation in the bloc, based on non-harmonized national consumer price indexes fell below 1.75 percent in March 2013, kept on falling, and is currently around 0.2 percent.

Prior to Thursday’s announcement, there was speculation the ECB might extend the deadline on its quantitative easing program. The ECB has extended the deadline before, upped its monthly asset-purchases of securities to 80 billion euros ($90 billion) from 60 billion euros and expanded the program to include corporate bond-buying.

Focus has now shifted to whether the ECB will announce an extension to the program later this year.

“On Thursday, the central bank raised its economic growth outlook for the euro zone slightly for 2016, but cut it for 2017 and 2018. It now sees growth in the 19-country bloc averaging 1.7 percent this year, having previously forecast 1.6 percent growth. It forecasts expansion of 1.6 percent in 2017 and 2018, down from its June forecast of 1.7 percent in both years.”

After lowering its growth forecasts for 2017 and 2018 slightly, ECB’s response back in September to the question of whether or not it’s going to extend the QE program past March: The ECB wasn’t sure. Check back later in the year.

So that was the ECB’s position on the future of QE back in September. But by early October another message started emanating from ECB policy-making circles: If the ECB decides to discontinue the QE program, don’t expect those monthly ECB bond purchases to end suddenly. Instead, much like what the Federal Reserve did to eventually end its QE program, markets should expect the end of the ECB QE’s to come in the form of a “taper” where the monthly ECB bond purchases are steadily lowered to eventually zero. And while the idea of “tapering” the QE makes a lot of sense and isn’t all that notable, having anonymous leaks to the press that the ECB was thinking about “tapering” at a time when the eurozone economies are still very fragile and everyone is wonder if the QE is going to be extended at all was pretty notable. And alarming [14]:

The Financial Times

Why eurozone bonds are rattled by taper talk

Germany’s 10-year Bund approaching a positive yield for the first time in two weeks

by: Elaine Moore
October 6, 2016

European bond markets are being rattled by talk that the European Central Bank is considering ways to call time on its €80bn-a-month bond-purchase programme before the March 2017 end date.

While the ECB has denied the reports, bonds across the eurozone are selling off — with Germany’s 10-year Bund yield on the cusp of turning positive for the first time in two weeks.

What’s rattling traders?

On Tuesday, Bloomberg published a story citing unnamed sources who claimed that the ECB was thinking of winding down its bond purchases in steps of €10bn a month ahead of its plans for QE to end in March, triggering an immediate jump in yields across bond markets.

The ECB is adamant that QE tapering is not up for discussion, with Michael Steen, head of media relations at the ECB, tweeting that the “governing council has not discussed these topics, as Draghi said at last press conference and during testimony at the European Parliament”.

Is this a taper tantrum?

Taper is not a word financial markets like to hear. Benchmark 10-year government bond yields of Germany, France, Italy and Spain all jumped about 4 basis points in the space of an hour and have continued to climb.

The moves illustrate how dependent investors have become on mass bond-buying programmes from central banks in Europe, the UK and Japan — but so far this sell-off does not compare with the “taper tantrum” triggered in 2013 by the US Federal Reserve plans to slow down its QE purchases.

Yields on Germany’s 10-year Bund — a proxy for wider European markets — are up a few basis points not percentage points and remain far lower on the year.

What do investors think?

Bond strategists and fund managers seem torn between suspicion that there is no smoke without fire and conviction that with eurozone inflation still low, any talk of tapering seems premature.

JPMorgan notes that views attributed to anonymous “sources” should be viewed with caution, noting that ending QE and raising interest rates would be difficult with inflation at current rates.

In fact, falling bond yields in recent months suggest investors had been expecting the ECB to relax its self-imposed limits and expand the universe of assets it can buy in order to address scarcity in the eurozone government bonds eligible for QE.

Frederik Ducrozet at Pictet has another idea. Perhaps, he says, conversations about tapering are being used to soften up ECB governing council members who oppose an extension of the programme — such as Jens Weidmann, head of the Bundesbank.

“The leaks could also be a superficial concession to the hawks ahead of a decision to extend QE,” he says. “A way to reassure them that an exit plan for QE exists, even if it is enlarged in the short term.”

What will happen next?

The next meeting of the ECB’s governing council is on October 27 but policymakers are not expected to make a decision on QE until later in the year, after the inflation forecast for 2019 is published. If inflation looks as though it will continue to undershoot then the case for QE extension will be stronger.

Andrew Bosomworth, Pimco’s head of portfolio management in Germany, says QE must end at some point, but points out that it will be a delicate balancing act.

“It will be difficult for the ECB to stop QE without there being an impact on bond yields,” he says. “And the ECB has to be careful to navigate the exit in such a way that yields do not rise to such levels that indebted countries have difficulty — something that could reignite the threat of another eurozone sovereign debt crisis.”

“Bond strategists and fund managers seem torn between suspicion that there is no smoke without fire and conviction that with eurozone inflation still low, any talk of tapering seems premature.”

Yeah, it’s hard to see why talk of a how the ECB might “taper” the QE program wouldn’t spook the markets. But the reason such talk would spook the markets – the reason being that the eurozone economies are still dangerously fragile and ending QE prematurely could be a disaster – also happens to be the reason such talk is hard to interpet. Because tapering the QE makes absolutely no sense in the current context. And yet such talk did reportedly take place, at least according to anonymous sources, although the ECB denied the reports.

The ECB’s Less Than Enthusiastic Response to Trump in November

So what did the ECB finally decide to do about the future of the QE program during its December 8th meeting? Well, before we get to that, note that there was another rather significant event that took place recently that would also reasonably impact the ECB’s decision-making regarding the future of QE: the election of Donald Trump. And based on the comments coming from the ECB officials in the weeks following Trump’s win, despite the expectations of rising inflation and the talk of a new US fiscal stimulus program, the ECB officials didn’t appear to see a Trump administration as likely helpful for the eurozone. And possibly very unhelpful [15]:

Reuters

ECB fears populist backlash after Trump’s win: sources

By Francesco Canepa and Balazs Koranyi | FRANKFURT
Fri Nov 18, 2016 | 10:13am EST

European Central Bank officials are growing increasingly worried that Donald Trump’s victory in the U.S. presidential race may harm the euro zone by hurting trade with the United States and fuelling populism.

Speaking publicly and behind the scenes, ECB officials emphasise any U.S. shift towards protectionism under Trump could hurt the already fragile euro zone economy and pave the way for an even stronger backlash against globalisation and the euro project.

This could hinder the ECB’s efforts to revive growth and inflation in the euro zone just as the economic picture was starting to look less bleak.

If they only looked at financial markets, ECB rate setters should be moderately pleased: euro zone inflation expectations, bond yields and stocks have all gone up since Trump’s victory, showing investors are betting on spending-led stronger U.S. economic growth.

In addition, higher bond yields have eased immediate concerns the ECB may run out of German debt to buy in its 1.74 trillion euros asset-purchase programme, the centre-piece of its stimulus strategy.

However, top officials stress the situation is far more complex than this and the ECB still looks still set to announce an extension of its bond buying beyond their March deadline at the bank’s Dec. 8 meeting.

First, rising borrowing costs for indebted peripheral governments show that investors are pricing in rising political risk in the euro zone as anti-globalisation and eurosceptic voices are emboldened by Trump’s win, which came hard on the heels of the Brexit vote.

This was particularly visible in Italy where the government’s borrowing costs were on track on Friday for their biggest two-week rise since the 2012 debt crisis and banking stocks fell ahead of a Dec. 4 referendum that could unseat pro-euro Prime Minister Matteo Renzi.

“The overall (market) signal is not clear cut,” a central bank official said, stressing it was still too early to consider any countermove.

Second, Vice President Vitor Constancio has warned that any fiscal easing in the United States — such as Trump’s planned infrastructure spending — may not benefit the euro zone if the new U.S. administration sticks to its ‘America first’ pledge, hurting Europe’s exports to its biggest trading partner.

Even a hawkish member of the ECB’s Executive Board, Yves Mersch, warned that growth in the euro zone was still “fragile” and the inflation pick-up not yet sustainable.

This was further emphasised by President Mario Draghi, who said on Friday the recovery relied on continued monetary support from the ECB.

Both Mersch and Draghi also warned that rolling back financial regulation could pave the way for a repeat of the 2008 crisis, a thinly veiled reference to Trump’s campaign promise to ease those rules.

Meanwhile, confidence remains low that euro zone governments will heed the ECB’s long-standing call for greater fiscal spending in surplus countries such as Germany, despite a European Commission’s plea for looser strings this week.

“In principle, we welcome any proposal for growth supportive fiscal policy,” Mersch told Reuters this week. “But we have not seen the details and there have been some disappointments in this regard in the past.”

“Speaking publicly and behind the scenes, ECB officials emphasise any U.S. shift towards protectionism under Trump could hurt the already fragile euro zone economy and pave the way for an even stronger backlash against globalisation and the euro project.”

Well, that certainly sounds like a Trump victory would make the ECB more, not less, likely to announce an extension of the extend the QE during its December 8th meeting. And given that rising bond yields in response to Trump’s victory increased the number of German bonds above -0.4 percent, more bonds will be available for the ECB to purchase and, one might assume, the ECB would be less likely to pursue the option of lowering the minimum bond yield the ECB can purchase below that -0.4 threshold.

The ECB’s Very Disappointing December. Very Vaguely Disappointing

So let’s take a moment to summarize the ECB’s QE conundrum this year:

1. The QE program was expanding back in March from 60 billion to 80 billion euros in bond purchases each month, reflecting persistent near-deflation and weak economies.

2. The current QE program is schedule to end in March of 2017, despite the fact that the eurozone inflation levels are close to 0 percent and its economies remain extremely weak.

3. The ECB’s QE program has several self-imposed rules that determine which bonds, and in what volumes, the ECB can purchase and because of those rules and the lack of German bonds above a -0.4 percent yield, a situation was approaching were QE program couldn’t continue without breaking those rules.

4. Ireland and Portugal were also hitting a QE wall due to the QE rules that caps the total ECB bond holdings to 33 percent for a given country and had already reduced their QE bond purchases below what the “capital key” allowed because of this.

5. If Portugal’s bond rating is cut by the last remaining credit rating agency to give it an investment-grade rating, Portugal is out of the QE and back into “bailout” austerity territory.

6. Heading into the ECB’s September 8th meeting, the markets were expect an announcement of an extension of the QE program past March. That didn’t happen. Although a cut in the economic growth forecast did happen.

7. In early October, reports that the ECB was already engaging in “taper talk” confused and spooked the markets.

8. And, finally, following the election of Donald Trump, ECB officials made it clear that they saw this as increasingly, not decreasing, the risks for the eurozone economies.

And given all that, did the ECB finally drop the “capital key” or the 33 percent cap like most experts recommended so it could stop buying German bonds (driving yields deeper into negative territory) and focus on weaker economies? Of course not. Instead, it cut the minimum deposit rate to below -0.40 so it could find more eligible German bonds. And also cut the total ECB monthly QE bond purchases by 25 percent, a move widely interpreted as the start of a much-feared premature “taper” [16]:

The Wall Street Journal

ECB Extends but Scales Back Stimulus, Whipsawing Markets
Bank’s move to buoy Europe’s economy comes days before Fed is expected to raise interest rates in U.S.

By Tom Fairless
Updated Dec. 8, 2016 3:07 p.m. ET

FRANKFURT—The European Central Bank prolonged its extraordinary lifeline to weak eurozone economies on Thursday, just days before the U.S. Federal Reserve is expected to move in the opposite direction and raise interest rates.

That divergence, along with difficulty in reading the nuances of the ECB’s action, caused investors to initially boost the euro before sending it lower as U.S. equity markets hit record highs.

The ECB surprised markets by saying it would slow the pace of its asset purchases, sparking a debate over whether the ECB had started down the path toward ending its monetary stimulus. Such a move—swiftly denied by the ECB—might be welcomed by some of the bank’s top officials, who are eager to signal an eventual exit.

Instead, the ECB’s decision was mostly taken as a sign the eurozone badly needs the type of support that the Fed next week could begin removing from the U.S., amid evidence and expectations of solid economic growth there.

The ECB said on Thursday it would extend its so-called quantitative easing program by nine months, until at least the end of next year, taking its total size above €2.2 trillion ($2.36 trillion). But starting in April, the bank will reduce the value of securities it buys per month to €60 billion from €80 billion.

Investors had considered such a move unlikely, betting that the ECB would continue to buy bonds at the current pace for at least another six months. Financial markets initially reacted negatively, with the price of shares and bonds falling sharply, and the euro rising against the dollar. Markets later reversed much of that fall.

The ECB’s decision to slightly lift its foot off the gas, as some saw it, comes despite sluggish growth and mounting political uncertainty across the 19-nation eurozone, which faces a string of major elections next year and fallout from Italy’s rejection of constitutional changes earlier this week. The move is likely to have been backed by some hawkish members of the central bank’s 25-member governing council, who have earlier signaled they seek a clear path out of the bank’s easy-money policies.

ECB President Mario Draghi took pains at a press conference Thursday to stress that the bank’s decision didn’t amount to tapering, or winding down, the bank’s stimulus. He warned that inflation in the eurozone remained too weak and said the ECB would keep buying bonds for some time.

“There is no question about tapering,” Mr. Draghi said. “Tapering has not been discussed today.”

Massive central-bank buying has helped buoy markets in recent years, and investors keep buying on the belief that such stimulus will continue. But more recently, investors have debated whether the ECB would begin to taper its aid in light of a rosier economic picture and concerns over potential side effects of its historically loose monetary policy.

On Thursday, investors decided the ECB, for now, wasn’t looking to turn off the taps.

Still, many investors weren’t convinced by Mr. Draghi’s arguments. At times on Thursday, the ECB chief veered into semantic gymnastics in an apparent effort to avoid the kind of “taper tantrum” seen in the U.S. in 2013, when the Fed suggested it might wind down its own bond-purchase program.

True tapering, Mr. Draghi argued, would involve gradually reducing the pace of bond purchases to zero. That move wasn’t discussed “and is not even on the table,” he said.

“This was a taper, as much as [Mr. Draghi] wants to deny it,” said Tim Graf, European head of macro strategy at State Street in London. But Mr. Graf welcomed said the ECB’s decision to extend its purchases for longer than expected would postpone any fresh debate on the QE program until after key European elections next year.

“The big Christmas present was time,” Mr. Graf said.

Mr. Draghi said the ECB’s decision had received “very, very broad consensus” from the bank’s 25-member governing council. Top ECB officials have been raising concerns about the adverse side effects of the bank’s easy-money policies. Bundesbank President Jens Weidmann, long an opponent of the ECB’s bond purchases, voted against Thursday’s decision.

“This is a step in the right direction,” said Clemens Fuest, president of Germany’s Ifo economic institute, a prominent critic of the ECB’s stimulus policies.

Michael Heise, chief economist at Allianz SE in Munich, pointed to the ECB’s statement that it could accelerate its bond purchases again if needed. That “can’t be described as tapering,” Mr. Heise said.

Others were less convinced. “Today was a missed opportunity to provide some sort of support to the market into a very uncertain political calendar in 2017,” said Patrick O’Donnell, an investment manager at Aberdeen Asset Management [17].

The ECB also announced changes to the design of its QE program on Thursday, to ensure it can continue to find enough bonds to buy. Mr. Draghi said that from January the ECB could start buying debt that yields below the minus 0.4% interest rate it pays on commercial bank deposits, something its own rules had barred it from doing. That move was aimed at addressing a scarcity of German bonds. And Mr. Draghi said that the ECB would start buying bonds with maturities of one year, down from the previous minimum maturity of two years.

The ECB also announced changes to the design of its QE program on Thursday, to ensure it can continue to find enough bonds to buy. Mr. Draghi said that from January the ECB could start buying debt that yields below the minus 0.4% interest rate it pays on commercial bank deposits, something its own rules had barred it from doing. That move was aimed at addressing a scarcity of German bonds. And Mr. Draghi said that the ECB would start buying bonds with maturities of one year, down from the previous minimum maturity of two years.”

Yes, one of the worst options the ECB had for extending its QE program – dropping the lower limit on the bond yields it could purchase so it could find more German bonds to buy – is the option it ended up going with. And while Bundesbank president Jens Weidmann voted against the ECB’s decision to extend the QE to the end of 2017, it’s hard to imagine that he wasn’t extremely pleased by the overall outcome. After all, the markets were generally expecting a QE extension heading into that meeting. But they weren’t expecting the start of a QE taper too. Or something that could be interpretted as the start of a taper. And if the president of Germany’s Ifo economic institute thinks this was a “step in the right direction”, jens Weidmann would almost certainly agree:


The ECB’s decision to slightly lift its foot off the gas, as some saw it, comes despite sluggish growth and mounting political uncertainty across the 19-nation eurozone, which faces a string of major elections next year and fallout from Italy’s rejection of constitutional changes earlier this week. The move is likely to have been backed by some hawkish members of the central bank’s 25-member governing council, who have earlier signaled they seek a clear path out of the bank’s easy-money policies.

“This is a step in the right direction,” said Clemens Fuest, president of Germany’s Ifo economic institute, a prominent critic of the ECB’s stimulus policies.

Now, keep in mind that ECB president Mario Draghi went to lengths to assure markets that this wasn’t actually the start of a true taper like Weidmann or the rest of the pro-austerity crowd would prefer. But also keep in mind that Draghi’s explanation for why this shouldn’t be interpretted as the start of a taper – that a 25 percent cut in the monthly bond purchases shouldn’t be considered the start of a taper because the cut wasn’t declared as part of an overall plan to bring the monthly asset purchases down to zero – isn’t exactly convincing. Because while it’s certainly possible that the cut in monthly bond purchases isn’t part of a secretly planned taper, it’s also the case that if the ECB wanted to start the taper now, but didn’t want to officially announce it and spook the markets, doing something like declaring this cut in bond purchases at the same time the ECB announces a 9 month extension to the QE program – when the markets were expecting a six month extension [18] – is the kind of vague mixed messaging we might expect from the ECB.

So it’s possible we could be seeing the stealth start of a real taper. Or maybe Draghi was sincere where he said the ECB is ready to expand the QE program as needed and tthe ECB’s announcement on Dec 8 was basically a temporary compromise between the hawks and doves. But also note the other context the ECB’s decision to announce a cut in the QE while also announcing a 9 month extension of the QE program instead of the expected 6 month extension: If the ECB had announced a 6 month extension, that would set the QE program to expire in September 2017 instead of December 2017. And what’s happening between September and December of 2017? Germany’s federal elections in October.

And it’s that context that raises the question of whether or not the ECB’s surprise decisions on Dec 8 to to cut asset purchases while extending QE to the end of 2017 was basically all about trying to assuage ongoing German voter resistance to QE with a QE cut that looks like the start of a taper while also trying to avoid the need for the ECB to make a big new a public debate over what to do next debate with the QE. It would also help explain the decision to find more bonds to purchase by lowering the lower limit on eligible bond yields so the ECB can purchase more German bonds instead of other options like dropping the “capital key” which would have shifted the ECB’s focus away from a “QE that helpds everyone equally” model to a “QE that helps the countries in need the most” model.

Also don’t forget that elections in France and the Netherlands are also scheduled for next year and the far-right candidates just might win in both cases. So, if eurozone’s political zeitgiest goes horribly awry next year, we could see the AfD surging in Germany [19], Marine Le Pen winning in France [20], and Geert Wilders’s PVV dominating the Netherlands’ elections in March [21]. Given all that, it probably wouldn’t be too suprising if the ECB decided to start signaling a QE taper simply to take to some of the political heat off the ECB in each of these looming elections in countries where the far-right is on the rise. In other words, it’s possible the ECB crafted its Dec 8 announcment for its 2017 QE specifically minimize the inevitable politicization of QE that’s guaranteed to take place next year. And yes, doing that would, itself, be an act of politicization, but it would be an act of preemptive politicization designed to reduce an expected future politicization of the ECB.

So was all that part of the ECB’s underlying logic for its December 8 QE decision? It sure seems possible, and if so, it also raises the question of just what the ECB would be doing if it was basing its decisions solely on the economics of the situation. And while we don’t get to know how the ECB would have acted under a different political environment, also note that on the same day the ECB announced is extended/tapered QE plan, it also provided its forcast for 2019. A forecast that once again predicts that the ECB will miss its goal target of hitting 2 percent inflation by 2019 [22]:

Reuters

ECB makes little change to growth and inflation forecasts

Thu Dec 8, 2016 | 8:53am EST

The European Central Bank left its economic growth and inflation forecasts largely unchanged on Thursday, predicting that price growth would raise slowly but again miss its target of close to 2 percent in 2019.

The ECB slightly increased its 2017 growth forecast to 1.7 percent from 1.6 percent seen in September and lifted its 2017 inflation forecast to 1.3 percent from 1.2 percent projected three months ago, ECB President Mario Draghi said at a news conference.

In its initial projections for 2019, the ECB put inflation at 1.7 percent, still below the target it has undershot for more than three years despite unprecedented stimulus aimed at reviving economic growth and boosting consumer prices.

“In its initial projections for 2019, the ECB put inflation at 1.7 percent, still below the target it has undershot for more than three years despite unprecedented stimulus aimed at reviving economic growth and boosting consumer prices.”

Yes, for more than three years now, the ECB has failed to meet its 2 percent inflation target and its projections for 2017-2019 continue to undershooting that target, following years of the ECB consistently overestimating its inflation projections only to later revise them lower while making new overly optimistic expectations [23]. But despite this track record, it’s worth pointing out what the ECB did accomplish with its unprecedented monetary stimulus: avoiding the kind of outright deflation that would make the eurozone’s current economic woes look like a picnic. That’s something. It could be worse.

The Unofficial De Facto Portuguese Taper

Still, while avoiding a deflationary death spiral is indeed a positive achievement it’s not an adequate achievement. The eurozone is just one shock away from that same deflationary death spiral. So if we really are seeing the ECB “settle” for failing its 2 percent inflation target indefinitely – and that’s the message the ECB is sending when it issues a quasi-taper on the same day its 2019 inflation projections continue to fail to meet its that target – that’s rather ominous. And, unfortunately, for Portugal, the ECB’s announced QE plans are already looking rather ominous [24]:

Reuters

Portugal’s borrowing costs move above corporates as ECB effect fades

* Portugal’s borrowing costs move higher than BB-rated companies
* QE changes favour short-dated bonds from higher-rated countries
* Possibility of DBRS downgrade hangs “like sword of Damocles”

By Abhinav Ramnarayan
Tue Dec 20, 2016 | 8:41am EST

LONDON, Dec 20 Portugal’s borrowing costs have risen above those of a group of similarly-rated European companies, on persistent concerns the European Central Bank will struggle to buy Portuguese government bonds after changes to its asset-purchase programme.

Governments tend to enjoy better borrowing rates than companies with similar credit ratings as government credit is seen as the least risky. All other borrowers pay a premium.

This effect has been exacerbated by the ECB’s bond-buying scheme, launched in March 2015 and focused on government debt. But last week the ECB made changes to the scheme that analysts said would see purchases concentrated on highly-rated bonds.

This graphic tmsnrt.rs/2hVdYBl [25] shows how over 2016 the yield on Portugal’s 10-year government bond has, unusually, risen above the yield on an index of European corporates with the same rating as the sovereign.

Portugal 10-year bond, rated Ba1/BB+/BB+ by the three main ratings agencies, is now 13 basis points (bps) above the Reuters index of 10-year double-B-rated European corporate bonds .

By comparison, Spain’s 10-year government bond – rated BBB – yields 25 bps less than an index of triple B-rated bonds and A-rated Ireland’s 10-year bond yields 43 bps less than the single-A index.

The ECB also buys investment-grade corporate bonds under its asset-purchase scheme, albeit in much smaller volumes.

Portugal is also rated BBB (low) by DBRS, the only agency to make the sovereign investment grade. It maintained the rating in October.

“To me (the reversal) shows that the ECB support for Portugal is no longer the same and it is now trading more according to its rating,” said Commerzbank strategist David Schnautz.

“The changes to the ECB’s bond-buying programme leave Portugal hanging because they don’t address the specific problems Portugal faces in terms of QE eligibility,” he said.

Last week’s changes will allow the ECB to buy bonds with maturities of less than two years and bonds yielding less than the deposit rate.

Both changes imply the ECB will concentrate its purchases on higher-rated countries and not on the likes of Portugal, which has a limited amount of short-dated debt and no bonds yielding less than the minus 40 basis point deposit rate.

“This effect has been exacerbated by the ECB’s bond-buying scheme, launched in March 2015 and focused on government debt. But last week the ECB made changes to the scheme that analysts said would see purchases concentrated on highly-rated bonds.

So despite the fact that Portugal and Ireland were already deviating from the QE “capital key” rule and buying fewer bonds than their the capital key warranted due to concerns over the QE 33 percent cap rule, the ECB decided to lower the minimum yields on QE-purchased bond (so it could buy more German bonds without breaking the capital key for Germany) and not drop the capital keys or the 33 percent cap to make more of Portugal’s bonds available. And as analysts observe, this all indicates that the ECB is going to be concentrating its QE bond purchases on highly-rated bonds even though the whole point of some like QE is to shore up weaker bond markets and give them time and room to heal:


Portugal is also rated BBB (low) by DBRS, the only agency to make the sovereign investment grade. It maintained the rating in October.

“To me (the reversal) shows that the ECB support for Portugal is no longer the same and it is now trading more according to its rating,” said Commerzbank strategist David Schnautz.

“The changes to the ECB’s bond-buying programme leave Portugal hanging because they don’t address the specific problems Portugal faces in terms of QE eligibility,” he said.

Last week’s changes will allow the ECB to buy bonds with maturities of less than two years and bonds yielding less than the deposit rate.

Both changes imply the ECB will concentrate its purchases on higher-rated countries and not on the likes of Portugal, which has a limited amount of short-dated debt and no bonds yielding less than the minus 40 basis point deposit rate.

Both changes imply the ECB will concentrate its purchases on higher-rated countries and not on the likes of Portugal, which has a limited amount of short-dated debt and no bonds yielding less than the minus 40 basis point deposit rate.”

So the ECB’s latest QE changes appear to be oriented to allowing it to buy more German bonds and less Portugese bonds. And absolutely nothing was done about the issue of Portugal approaching that 33 percent cap. In other words, the ECB’s decision to orient its bond purchases away from Portugal is very much aligned with its decision to do nothing about that 33 cap: while it’s unclear if the overall QE program is about to undergo a taper, it’s more more clear for Portugal: Portugal’s QE participation is getting tapered one way or another.

All in all, whether or not the ECB is starting a QE taper for real or just for theatrics to placate anxious electorates, the motive for that move probably has a lot more to do with the eurozone’s political circumstances vs the macroeconomic need for more QE. And if that is the case and there really is concern at the ECB that its QE programs could become focal point for anti-eurozone partisan ire in the upcoming elections, perhaps it would be worth pointing out to those angry electorates, especially the electorate in Germany, that the rules the ECB previously put in place to ensure that QE wouldn’t help one country more than another (like the “capital keys” and “no more than 33 percent of a nation’s sovereign bonds can be held by the ECB” rules) has resulted in a situation where the countries most in need of QE support get the least. And vice versa [26]:

The Wall Street Journal

ECB’s New Dilemma: Neediest Nations Receive Less Stimulus
Partly due to bank’s rules, its bond-buying has undershot Portugal and Ireland

By Jon Sindreu
Dec. 19, 2016 6:00 a.m. ET

When it extended its bond-purchase program this month, the European Central Bank needed to choose between buying bonds at extremely negative returns or gearing stimulus toward eurozone nations that need it the most.

It chose the former.

Every move by policy makers in the single-currency eurozone is supposed to avoid benefiting some nations over others. But now, due in part to the design of ECB rules, more stimulus is delivered to the healthiest economies and less to those that are lagging behind.

This month, ECB President Mario Draghi said the bank would extend the central bank’s asset-purchase program from its projected March end date until December 2017. This change has forced officials to relax the rules guiding the program to avoid running out of eligible bonds to buy.

The central bank has been mandated to spread its purchases according to how much capital each country has at the ECB. Keeping this quota intact has been a goal for politicians in Northern Europe, chiefly Germany, as it helps ensure countries don’t have to share the debt burdens of others through the central bank.

However, the ECB already bought debt of the eurozone’s most distressed nations under an emergency program from 2010 to 2012 and is now having to buy less from these countries than national quotas would dictate.

This is because the ECB had two other main self-imposed rules constraining its actions. First, it isn’t allowed to own more than one-third of a single issuer’s outstanding debt. Second, it couldn’t buy bonds with yields below its own deposit-facility rate, currently at minus 0.4%.

As a result, since it expanded bond buying in March, the ECB has undershot Portuguese bond purchases by well over €3 billion ($3.1 billion) and overshot purchases in Germany by €8 billion.

The aim of the bond-buying program is to help the economy by lowering borrowing costs further, and Portugal clearly needs it more: Its 10-year government yield is almost at 4%, second only to that of Greece, reflecting a foundering economy. In Germany, a country at full employment, the 10-year yield is close to 0.3%.

But the central bank’s decisions this month did little to address concerns that it will keep undershooting purchases in the neediest nations.

“We don’t think the ECB announcement is good for the periphery,” said Bert Lourenco, head of rates strategy for Europe, Middle East and Asia at British lender HSBC Holdings PLC.

To expand the pool of eligible assets, officials chose to remove the prohibition to buy bonds below the minus-0.4% deposit rate, which will allow the ECB to buy more German and Dutch bonds. They didn’t touch any of the main obstacles that are driving the central bank to buy less in Portugal and Ireland.

The reason, Mr. Draghi said, is that “there was an increasing awareness of the legal and institutional constraints that would make such a change difficult.”

The decision isn’t painless for Germany, either. When the ECB buys a bond yielding, for example, minus-0.5%, it does so by creating a deposit in its own accounts. If the rate it pays on this deposit is minus-0.4%, it means it is getting less from the bond than it is paying, exposing itself to losses.

In reality, national central banks do most of the purchases at the ECB’s behest, and yields are only negative in the safest eurozone nations. In Germany, all bonds up to five years of maturity return less than minus-0.4%. This means that removing this rule will hurt, most of all, the German Bundesbank’s profits.

Still, “the Germans prefer to take the heat on their own purchases than to relax constraints on the periphery,” said François Savary, chief investor at Geneva-based advisory firm Prime Partners. “It’s a political choice.”

To be sure, these bonds may still prove profitable if rates go lower in the future. And even if some specific bonds generate paper losses, overall purchases are unlikely to.

Also, the stimulus ideally reaches beyond borders. Germans, for example, may use lower borrowing costs to import more products from Portugal.

But some investors see the inflexibility of the rules as another concerning sign of the political struggle of the eurozone to stay together.

While profits and losses don’t theoretically mean much to central banks, they often do in practice.

Bundesbank President Jens Weidmann spoke against the removal of the deposit floor earlier in the year, while German economists—like Hans-Werner Sinn, president of the Ifo Institute for Economic Research—have often suggested all of the ECB’s actions end up hiding under-the-table bailouts for southern European countries.

Any step toward aiming monetary policy at the neediest countries has long been politically controversial and challenged in German and European courts. Some fear these constraints on the ECB could impair its ability to deliver more stimulus.

“Political constraints appear to now be dominating,” Bank of America Merrill Lynch told its clients last week. “Come another large shock, the central bank would have little ammunition left.”

“Every move by policy makers in the single-currency eurozone is supposed to avoid benefiting some nations over others. But now, due in part to the design of ECB rules, more stimulus is delivered to the healthiest economies and less to those that are lagging behind.

And that’s where we are with the ECB’s QE: the healthiest economies get the greatest benefit while the countries that most need that QE stimulus are getting slowing pushed out of the program:


This month, ECB President Mario Draghi said the bank would extend the central bank’s asset-purchase program from its projected March end date until December 2017. This change has forced officials to relax the rules guiding the program to avoid running out of eligible bonds to buy.

The central bank has been mandated to spread its purchases according to how much capital each country has at the ECB. Keeping this quota intact has been a goal for politicians in Northern Europe, chiefly Germany, as it helps ensure countries don’t have to share the debt burdens of others through the central bank.

However, the ECB already bought debt of the eurozone’s most distressed nations under an emergency program from 2010 to 2012 and is now having to buy less from these countries than national quotas would dictate.

This is because the ECB had two other main self-imposed rules constraining its actions. First, it isn’t allowed to own more than one-third of a single issuer’s outstanding debt. Second, it couldn’t buy bonds with yields below its own deposit-facility rate, currently at minus 0.4%.

As a result, since it expanded bond buying in March, the ECB has undershot Portuguese bond purchases by well over €3 billion ($3.1 billion) and overshot purchases in Germany by €8 billion.

“As a result, since it expanded bond buying in March, the ECB has undershot Portuguese bond purchases by well over €3 billion ($3.1 billion) and overshot purchases in Germany by €8 billion.”

That’s the situation: Thanks to all the self-imposed rules the ECB put in place in order to avoid any possibility that the QE program could end up helping one eurozone country more than another, largely at the behest of the eurozone’s wealthier members like Germany and the Netherlands, the ECB’s QE is now more of a stimulus program for Germany than countries the like Portugal that actually need it. Will that little fun-fact end up penetrating the far-right “populist” fervor bound to dominate the political scene in next year’s critical eurozone elections? Probably not, but it should [27].