Editor’s note: This article was authored right before the ECB this morning officially announced (or “leaked”) the launch of QE – the headline reflected that fact, but the rest of the text has not been amended.
According to a January 15th report from Deutsche Bank Research, a favorable ruling from the Advocate General of the European Court of Justice gives the European Central Bank (ECB) the green light to go all out for a more robust QE program.
The U.S. Fed’s quantitative easing program has been long and drawn out, but it has clearly had some stimulative impact on the American economy. The idea of a similar QE program for the Eurozone has been opposed every step of the way by the Germans and a few others, but the clear signs of deflation in the Euro economy and the clamor from highly indebted members of the EU have left ECB President Mario Draghi with little choice.
ECB QE a “done deal”
In their report, Deutsche Bank analysts Barbara Boettcher and colleagues argue: “With the ECJ hurdles comfortably cleared, inflation breakeven rates tumbling and Benoit Coeure’s dovish comments accumulating, QE feels a done deal.”
They note the consensus expectation is that the QE program will be announced on January 22nd following a scheduled ECB meeting. That said, the analysts point out that: “ECB QE is complex and still controversial. The ECJ’s green flag for pari passu purchases means compromise on seniority is not necessary. But there are other challenging design decisions, from country coverage to volumes to the location of risk.”
Cap of 25% of CAC bonds
Boettcher et al. also note that the ECJ AG seemed to indicate the ECB will be limited to buying no more than 25% of CAC bonds.They note it is also likely that the ECB will apply a similar cap on non-CAC bonds so as to not introduce further distortion or the retroactive introduction of CACs.
The DB report also argues that an introduction of a cap on bond purchases will both limit the overall size of the QE program and the impact the distribution of the ECB purchases across countries. The analysts believe the ECB internal limit will actually be somewhat under 25% to avoid giving a small group of investors a blocking minority. They extend their argument to say the most likely course is that the ECB will purchase bonds with greater than 10-years maturity to reach its targeted balance sheet expansion.
