Global Daily – ECB fills core gap by buying more Irish bonds

by: Kim Liu , Han de Jong , Arjen van Dijkhuizen

We are in the process of publishing a series of economic and market outlooks for 2018. We will include short summaries in our Global Daily Insight with links to the publications. We kick off with our Global and China views. Please also see links to our FX and Government Bond Supply outlooks below. We will also continue our regular analysis of developments we find interesting as usual. Today, we analyse the latest ECB purchase data and deviations from the capital key.

Eurozone government bonds: ECB makes use of flexibility of QE programme – Data, which was released by the ECB today, showed that the Eurosystem bought EUR 62.6bn of bonds across its 4 bond purchase programmes in November. This is EUR 2.57bn more than the prescribed monthly EUR 60bn amount. As a result, the cumulative frontloading now stands at EUR 11bn. The central bank “frontloads” its purchases so it can create a buffer for periods in which liquidity will be lower than normal. Indeed, the ECB also announced that it will temporarily pause its purchases in the last 1.5 weeks of December in anticipation of lower market liquidity. We expect that the ECB will make use of its buffer so that it will start with a clean slate in the first month of 2019.

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The country specific data shows that the deviation of the actual purchases from the ECB’s revised capital key have increased for the supercore countries Germany and the Netherlands (combined total is EUR 600mn). Furthermore, the ECB has continued to overbuy French and Italian bonds, albeit at a generally lower pace than in previous months. Interestingly, the largest overbuying took place in Irish bonds. The ECB bought EUR 1.2bn of Irish bonds, which is around EUR 400mn more than prescribed by the capital key. It seems that the ECB filled the supercore bond purchase gap partially by buying more Irish bonds. Due to scarcity, the ECB has undershot its target for Irish bonds in the last 19 months. In October, an Irish government bond redeemed (IRISH 5.5% October 2017), so that Irish holdings in the ECB portfolio declined, which created more room for the ECB to buy again.

Finally, the ECB also released data which showed that the redemptions in November 2018 will amount to EUR 7bn. Of this amount, more than half (EUR 4.8bn) will consist of public sector bonds. The amount is on the low side of our expectations. However, we expect that over time the PSPP redemption amount will grow to around EUR 8bn, which is consistent with a stable redemption rate of 17% of all PSPP eligible issuers. (Kim Liu)

Global Outlook: Will Goldilocks stay in 2018? Sensational! That best describes how business confidence indices have developed in 2017 and in particular in recent months. While they have not been equally strong everywhere, they show that all the main regions of the world economy are growing nicely. More striking, the most recent of such indicators suggest that momentum, which was already strong, is increasing further. This is particularly true for the eurozone. As inflation has actually remained very subdued in 2017, this has been a year in which Goldilocks has come back to life. Can she stick around in 2018? We think it will. We expect corporate investment to grow more strongly. That would create jobs and incomes and would be positive for productivity. Judging by what corporates have recently been saying in surveys about their investment plans and what capital goods orders indicate, a significant strengthening of investment growth looks imminent in the US, the eurozone and Japan. And that makes sense as corporate profits are generally strong, credit relatively easily available and cheap. While we expect slowdown of China’s growth, we expect policymakers to keep it gradual (please see below), and therefore that it will not cause trouble for the global economy. On balance, we expect the cyclical forces pushing inflation higher will become stronger in 2018. Having said that, we also believe that the more structural factors will continue to work in the opposite direction. The result will be only a modest rise in inflation in the US and in the eurozone. The risks to our global economic outlook include the possibility of a sharper slowdown in China and a more significant rise in inflation, which could make central banks withdraw policy accommodation more quickly. For more please see our note here. (Han de Jong)

China Macro: Soft landing expected in 2018, despite debt-related risks –  In the past weeks, we have seen a flaring-up of China-related concerns, as Chinese bond yields rose further, with some spill-over to equity markets. While rising market interest rates add to debt issues and may lead to a further rise in NPLs and credit events, we still expect no systemic crisis or hard landing in our two-year forecast horizon. The authorities have focused their targeted tightening policies at the most risky parts of the financial system (including shadow banking), while keeping credit to the real economy flowing. That implies that outstanding credit to the real economy keeps rising, to almost 260% of GDP in Q1. That said, the gap between credit growth (gradually slowing) and nominal GDP growth (bolstered by reflation) has fallen to a six-year low. Moreover, credit to the corporate sector (the bulk of outstanding credit) has slowed, and the corporate credit to GDP ratio (around 165% of GDP) has been stable for a while. Furthermore, as China’s debt is mainly domestic and yuan-denominated and FX reserves are still very high, a debt crisis will not be triggered by external creditors. That leaves Beijing time to engineer something orderly, at least for the foreseeable future. To put it differently, the high and rising debt burden remains a key risk, but more of a long-term than a short-term one. Still given the prevailing risk’s and China’s rising role in the global economy, the likelihood that global financial markets will be impacted from time to time by a slowing, tightening China is high, even in a gradual slowdown scenario. For more please see our note here. (Arjen van Dijkhuizen).