The growing ECB bond-buying imbalance
EmailIt's worth keeping an eye on the ECB's sterilisation of its bond purchases over the coming weeks as there is a decent risk that there could be bumps along the way. Ever since the start of the ECB's bond-buying program in May 2010, the central bank has drained the equivalent amount of liquidity from the markets to that outstanding in bond purchases. This way, the ECB presents the program as a means to improve market functioning but not undertaking QE via the expansion of bank reserves. Still, there have been occasions when it has not managed to fully sterilise the bond purchases. These occasions have generally been owing to short-term liquidity preference on the part of banks, such as just before the repayment of 1yr ECB loans in June 2010 and again just before year-end last year when banks preferred to keep the liquidity on their books over year-end.
The chances of this happening again into this year-end remain high for three reasons. First, the amount outstanding is nearly three times that of this time last year. Second, the difference between the average rate in the 7-day sterilisation tenders and the rate at which deposits at the ECB are remunerated has narrowed and is currently only 10bp. The average has been 38bp this year, so there's been a good incentive to tie up surplus cash and earn a few basis points. Finally, stresses in money markets are clearly higher and especially in cross-currency swaps. This is also likely to increase liquidity preference over the year-end. But there's probably no need to panic. It's more likely to prove to a bump in the road, but if the ECB's bond-buying program continues to expand (as is likely to be the case), then there could be a more permanent imbalance as the amount to be sterilised increases and bank balance sheets decrease. This would amount to QE by accident, rather than by design or intent.
