The European Central Bank has already been able to positively impact financing costs in the Eurozone just through the announcement about its latest round of quantitative easing. However, the ECB corporate bond buying program won’t be a “game-changer,” believe economists at Capital Economics.
ECB corporate bond buying to begin in Q2
European Economist Jack Allen said in his March 23 report titled “Are ECB corporate bond purchases a game-change?” that he doesn’t think the ECB corporate bond buying program will be “enough to generate a meaningful recovery in investment.” He does think just the idea of it is having some positive impact, however.
The European Central Bank announced that it plans to purchase investment-grade non-financial corporate bonds starting toward the end of the second quarter. The goal of the program is to improve the current financing environment, although the details of it haven’t been finalized yet. At the time of the announcement, ECB President Mario Draghi said they hadn’t yet decided about whether they would buy non-bank financial firms’ bonds, so Allen explained that it’s unclear just how big the market for “non-financial” debt is.
He notes that data from the ECB indicates that non-financial corporate debt in the Eurozone sits at about €900 billion. He estimates that approximately €500 billion of that or 5% of the Eurozone’s gross domestic product could be investment-grade. However, he also says that this amount doesn’t seem like much because the ECB’s total quantitative easing program is planned to amount to approximately 18% of the region’s GDP.
Just the idea of ECB corporate bond buying having an impact
Allen believes that there are early signs that only the prospect of EBC corporate bond buying is positively affecting this asset class. For example, he said there are reports indicating that firms are beginning to issue new debt as a result of the announcement. Further, he said corporate bond yields’ spread over German Bunds with equivalent maturities has declined by approximately 20 basis points since the ECB’s new QE round was announced.
ECB tries to boost investments
The Capital Economics Economist adds that it’s possible ECB corporate bond buying will more directly boost investments in the Eurozone, noting that this part of the region’s economy has been the weakest part of aggregate demand. He pointed out that in the fourth quarter of 2015, investment was still 13% under its peak before the financial crisis, going on to demonstrate that increases in issuances of corporate bonds have been linked with increased investments in the past.
Caution on ECB corporate bond buying
Allen warns though that it’s just too early to know if ECB corporate bond buying will actually work. For example, he said that in practice, the central bank can’t buy €500 billion in corporate bonds as there’s a 33% issue limit on governments that will probably also apply to corporate debt. Further, he noted that the European Central Bank has not explicitly said how many corporate bonds it will buy, and even if it did buy up to the issue limit, he estimates this at only about €165 billion, which amounts to only two months of asset purchases.
And then there’s the issue of yields. He said even if the central bank is able to spur further decline in yields, there’s no way to know right now if it will result in a “sustained, significant rise in borrowing and investment.” He said there’s not much evidence right now that firms are short on liquidity, and he pointed out that companies in the Eurozone usually depend more on bank loans, which can be secured at extremely low interest rates right now.
Allen noted also that last year corporate bond yields and spreads were actually lower although issuance remained weak even then. He added that usually investment runs behind economic recovery, which he described as “still fairly slow.” He believes that economic growth will ease this year and that, as a result, companies will continue to be cautious about new investments.
“In all, we doubt that corporate bond purchases will do much to boost growth and inflation,” he sums up. “But the ECB has shown that it is still willing to adjust its QE programme to facilitate further monetary easing. Sooner or later, that willingness is likely to be tested again.”
