How Will ECB’s Purchase Programme Impact Investors?

Faced with stubbornly low inflation, the European Central Bank (ECB) has taken a leaf out of the Bank of Japan’s playbook. As well as implementing a negative deposit rate, in March it announced its ongoing asset purchase programme (APP) would not only rise to €80bn per month, but also include “investment grade euro-denominated bonds issued by non-bank corporations”.

The four main measures of the program

This accommodative package announced in March is intended to ‘further ease financing conditions, stimulate new credit provision and thereby reinforce the momentum of the euro area’s economic recovery and accelerate the return of inflation to levels below, but close to, 2% over the medium term’. The package consisted of four main measures.

Firstly, although broadly anticipated and priced-in by the market, the ECB announced cuts in its three policy rates,
including moving the rate for the deposit facility from -0.30% to -0.40%. Secondly, it announced an increase in the monthly purchases under the Asset Purchase Programme (APP) from €60 billion to €80 billion from April 2016. This, also, had largely been anticipated, although most commentators had expected an increase to around €70 billion. Then came the surprises. The third measure was a reintroduction of the Targeted Long-Term Repurchase Operations (‘TLTROII’), designed to offer attractive long-term funding conditions to banks to further ease private sector credit conditions and to stimulate credit creation
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The fourth, and very unexpected, measure was an expansion of the universe of eligible assets for the APP to include investment-grade euro-denominated bonds issued by non-bank corporations established in the euro area. The purpose of this newly announced Corporate Sector Purchase Programme (CSPP) is to ‘further strengthen the pass-through of the Eurosystem’s asset purchases to the financing conditions of the real economy’, and is due to commence towards the end of the second quarter of 2016.

What is the potential impact on investors ?

It could help provide support for the market, reducing the likelihood of any major sell-off in the near future, and smoothing volatility. The ECB ‘back-stop’ bid could therefore make holding European investment grade non-bank corporate bonds attractive, limiting any potential downside, at least in the near term.

However, this could go completely the other way, particularly if the size or nature of purchases are perceived to jeopardize market functioning and liquidity. Investors may see this as an opportunity to ‘cash in’ on their eligible holdings and instead move into other parts of the credit curve or different asset classes, with the potential for higher returns. To a large extent this is possibly the intention of the CSPP, driving portfolio rebalancing into less safe corporate sectors, such as high yield or SMEs, where the need for credit and market investment is more pertinent. It also helps to explain how the initial reaction to the announcement of the CSPP was not only a significant tightening in investment grade corporates, but also in bank debt and sub-investment grade spreads.

However, the counter-risk is that investors instead look to move into noneligible issues, such as the deals of non-Eurozone issuers, where there is more liquidity and better returns, and which would effectively provide an unintended benefit to untargeted sectors and corporations.

The first purchases under the programme

The European Central Bank bought 348 million Euros of corporate bonds in the first three days of such purchases in June, as part of its 1.74 trillion Euro scheme to revive growth and inflation. The figures are at the upper end of analyst predictions, indicating a strong start for the program and suggesting that the ECB was keen to show it can buy significant volumes.

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