Why Draghi’s Buying Spree for the ECB May Start Modestly

When Mario Draghi writes his first check to pay for asset purchases, he might not use much ink.

While the European Central Bank president pledged to start a program this month to buy asset-backed securities and covered bonds, initial buying in those markets will probably be modest, according to two euro-zone central bank officials who asked not to be identified because the matter is private. That will keep investors guessing on the scope of his intentions today as they bet the ECB will expand the range of securities it can buy.

Policy makers gathering in Italy for their monthly decision are under pressure to act after Draghi’s pledge to add as much as 1 trillion euros ($1.3 trillion) to the ECB’s balance sheet failed to rein in bets on a worsening price outlook in the euro area. Speculation on how far he’ll go sent Greek debt higher after the Financial Times said he wants looser requirements on the quality of assets the central bank can accept.

“For an immediate effect on inflation expectations, a fast implementation seems important,” said Johannes Mayr, an economist at Bayerische Landesbank in Munich. “In the short term, there’s room to disappoint given the lack of available assets, which would increase pressure to expand. Draghi should present himself as very open to that.”

Higher Returns

Calls for government-bond purchases have become louder since an offer of signature loans to banks last month attracted weak demand. Policy makers are in Naples for one of two meetings each year held away from Frankfurt. The ECB will announce its interest-rate decision at 1:45 p.m. local time tomorrow and Draghi will hold a press conference 45 minutes later.

All economists in a Bloomberg News survey predict officials will keep the benchmark interest rate at 0.05 percent and the deposit rate at minus 0.2 percent. That shifts the focus to the central bank’s asset-purchase plan, and how much Draghi has to say on its size and duration.

Investors in Europe’s $317 billion public ABS market saw the best returns in 20 months in September, after Draghi laid out his plan on Sept. 4. He pledged to reveal details of the program after the October meeting.

Bonds backed by mortgages to Greek civil servants rallied yesterday to the highest since the nation requested its first bailout in 2010. The ECB’s six-person Executive Board will propose that existing requirements on the quality of assets accepted are relaxed to allow purchases of some Greek and Cypriot ABS, the FT reported, citing unidentified people familiar with the matter. Greek sovereign debt rose the most in a month. An ECB spokesman declined to comment on the article.

Market Size

The planned asset purchases mark the ECB’s latest attempt to funnel money to companies and prevent the 18-nation economy from sliding toward deflation. Consumer prices rose an annual 0.3 percent last month, the least in almost five years. The central bank’s preferred measure of medium-term inflation expectations has extended its decline.

The plan complements a four-year funding program tied to the size of banks’ loan books that started two weeks ago. Banks borrowed 82.6 billion euros in the first so-called TLTRO, less than all estimates in a Bloomberg survey of analysts.

We “remain unconvinced that these measures will be sufficient to turn the downward trend in inflation expectations,” said Anatoli Annenkov, senior economist at Societe Generale SA in London. “Draghi will thus need to maintain a very dovish message, promising further action if needed.”

Limited Scope

Even so, the ECB president may not wish to offer much insight into the volume of the asset program as policy makers prepare the logistics of the operation. He said last month that it’s “very difficult to assess the size” of purchases.

“At the outset of the purchase program, it is possible that placed paper held by investors will be very hard to acquire,” said Marco Valli, chief euro-area economist at UniCredit Global Research in Milan. “The scope for actual purchases will crucially depend on the eligibility criteria set by the ECB, as well as the decision to target also retained bonds.”

Draghi told European lawmakers in Brussels last month that officials are looking at a “fairly wide range of simple and transparent ABS” and the size of the market will increase as a result of the ECB’s presence. Purchases will include existing and newly created ABS and those backed by residential real estate.

QE Option

An early idea last month foresaw the ECB outsourcing purchases to external asset managers, with national central banks buying shares in a fund, according to two officials familiar with the proposal. Policy makers rejected the draft and decided that purchases would be made by the ECB, on the recommendation of outside advisers, and held on its balance sheet, the officials said.

Should the plan fail to boost the outlook for consumer prices, Draghi may have to step up to large-scale buying of government debt. That threatens to widen a rift in the Governing Council, where Germany’s Jens Weidmann has already opposed the ABS plan.

“The ECB’s credibility is at stake so it cannot afford to allow inflation and inflation expectations to undershoot the target for too much longer,” said Andrew Bosomworth, a Munich-based portfolio manager at Pacific Investment Management Co. “I favor elevating QE to the central policy tool.”

(Source: Bloomberg)