03 April 2017

ECB: Bond scarcity and the ECB’s asset purchase programme

In his speech Benoît Cœuré, Member of the Executive Board of the ECB, addressed the low level of short-term yields of the euro area’s safest sovereign bonds and their apparent disconnect with those of overnight index swaps (OIS).

Mr. Cœuré said: “We have recently observed a widening of the spread between yields of two-year sovereign bonds of core jurisdictions and the OIS curve. We think this is likely to reflect a confluence of factors, namely regulatory factors, flight-to-safety flows as well as the direct and indirect effects of our purchase programmes.”

The relative contributions of each of these components are inherently difficult to assess. But the combination of growing excess liquidity and the need of investors without access to our deposit facility to park these holdings in a safe and liquid storage vehicle are likely to have been a measurable driver of recent developments. The direct impact of the Eurosystem’s purchases below the DFR is probably more limited.

Whether or not these developments should be a source of concern for policymakers depends largely on how persistent these effects will likely prove, as well as their implications for market functioning, and ultimately the transmission of monetary policy. Temporary blips can be safely ignored. But a silent and lasting decoupling of the short end of sovereign curves from our key policy rates warrants close monitoring by policymakers.

For monetary policy, the prevailing financial conditions should remain consistent, as they have been so far, with the monetary policy stance intended by the Governing Council. For financial stability, very depressed funding rates may incentivise sovereign bond holders to engage in more risk-taking, and banks to tilt their funding structures towards less stable wholesale funding.

These risks have not materialised so far. Now, how likely are they to materialise? In other words, how persistent could current conditions prove?

Some factors, such as regulatory demand for safe assets, are of a structural nature. They can be expected to persist. Other factors, which have driven short-term sovereign bond yield to record lows, are likely to be of a more temporary nature. In this regard, there is hope that the perceived political uncertainty, which has triggered flight-to-quality flows, will gradually dissipate and that investors rebalance their short-term fixed income again towards other bond markets.

To the extent that ECB‘s asset purchases have contributed to this development, the reduction of ECB’s monthly purchase pace from €80 billion to €60 billion as of today will provide some relief. At the same time, increasing liquidity in the hands of investors without access to the deposit facility will continue creating demand for safe assets. For the time being, these factors are therefore likely to continue exerting a certain degree of downward pressure on short-term bond yields.

Mr. Cœuré concluded: “What I can say with reasonable confidence today is that, as I suggested at the beginning of my remarks, so far we see no evidence that the current constellation of interest rates bears risks for the smooth functioning of markets, nor to financial stability or the transmission of our policy.“

Full speech

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