rahul.khanna's picture

Why ECB can't do a proper QE? & Why covered bond purchases are likely to fail?

ECB inaction will lead to either a liquidity crisis or slow growth for the rest of the decade, one indication of such a possibility is the dropping 5y5y forward inflation swap yields which broke below 2% in August/September and has only recently stabilised on back of Covered Bond Purchase Program. But given only €1.7 billion of assets are purchased last week, 5y5y inflation yields are likely to dip further. These numbers do not include purchases made on Thursday & Friday, which is likely to take the tally to €2.4 billion (still moderate).

(Click chart to enlarge - 5y5y Forward Inflation yield, EURUSD) 

The idea behind buying corporate bond instead of government securities is that excess cash straight to businesses will prompt them to reinvest their cash somewhere else and thereby support the economy. However, impact of covered bond purchases by ECB is likely to be limited with shortage of quality paper and other problems in scaling such an operation. Not to mention the lack of appetite companies will have for raising cash (then investing) in a struggling economy.                                                 

Peripheral yields are now calm as stress test results were better than expected, but the fear still remains that stabilising debt for peripheral countries would be more difficult with low inflation or deflation in the euro zone countries. It seems that ECB is doing whatever it can within its power, given lack of consensus on government bond QE within the Governing Council.

Draghi is helpless in taking hard measures because of Germany’s absolute no-no attitude to full blown government bond buying, or QE. Last thing ECB needs is losing the support of Euro zone most influential member and thus eroding confidence. Our focus going forward is to pay more attention to remarks by Jens Weidmann, also having a close eye on economic situation in Germany, because it’s Germany that holds the key to QE and Draghi is unlikely to make any significant inroads in his endeavour to put the economy back on track without a German veto.