The ECB went aggressive today and a big way. They were the last holdout in the move to quantitative easing (a.ka. printing money). They have lowered rates to a record low 1.00% and issued a statement that the European Central Bank will begin purchasing covered bonds (a.k.a propping up the market artificially). If you don’t think the reflation play is going to gain traction, you’re not in touch with present central banking and government fiscal policy.
Edward Hugh (the other Edward over at Global Economy Matters) told he me he thought this move significant. He said, “Just to bring to your attention that today’s covered bonds ECB decision, as well as being good for German banks who issue Pfandebriefe, is also aimed at Spain’s banks, enabling them to refinance.”
Later in the day, Marc Chandler, the Chief Currency Strategist at Brown Brothers Harriman sent out an investor notice that has the right tone to it about this move.
The ECB has taken a more aggressive than expected stance. Trichet announced that the ECB will purchase covered bonds (see below). The ECB had been expected to limit its non-traditional measures to the extension of the maturity of existing lending from 6 to 12 month maturities (which it did). In addition to extending the maturity of existing lending from 6 to 12 months (which was widely expected), the ECB took a more aggressive than expected step in announcing it would purchase EUR 60 bln of covered bonds.
The questions now are why the ECB chose to target this sector and whether the size of the EUR 60 bln of purchases will help meet the ECB’s agenda. The policy announcement does not appear to be aimed at reflating the economy. Trichet’s statement indicates the ECB is very committed to making sure inflation expectations are well anchored and the ECB President said he was encouraged by the recent improvement in inflation. The President also said the ECB would ensure that the policy measures would be unwound when needed. The new ECB policy does not appear to be designed to lower interest rates either (as is the case with the Fed where asset purchases help to lower mortgage and borrowing rates).
The fact that the ECB has targeted the covered bond market shows commitment to easing conditions in a segment of the market that has been severely hit by the financial market turmoil of the past year. European banks are heavy issuers in covered bonds (especially in France, Germany and Spain) and a crucial intermediate for European corporate access to credit. The fact that Germany is the main issuer (roughly EUR900m in 2007) should also facilitate implementation of the ECB purchase program. The covered bonds do have an advantage in that the assets backing the bond issues remain on the issuer’s consolidated balance sheet and the pool of assets must consistently back the covered bond. The ECB has chosen to announce that it may purchase, at some point, EUR 60 bln of the EUR1.5 tln covered bond market in the euro zone (2007 figure, European Covered Bond Council).
While the size is small – as the Fed’s purchase of $300 bln of Treasuries is a small fraction of the overall Treasury market – the ECB’s announcement, while symbolic in nature, is a step in the right direction and could lead to some small improvement in the covered bond market as did news the Fed was considering purchasing mortgage backed securities. The Fed then went on to implement the program. It is unclear if and when the ECB does implement the program. The statement still leaves our long term view of the euro unchanged. We still expect the early steps by US officials to address the crisis will see the US macroeconomic picture improve relative to the euro zone. At the moment, positive news out of the US is helping to ease global tensions and support foreign currencies. Over the longer term, this will fade and strong US macroeconomics will help the dollar gain traction against the euro.
While Marc does not see this as a reflation trade or a play to target interest rates, it should be clear the ECB are propping up the Spanish and German property markets in particular. My understanding is that Bank of Ireland, AIB, Anglo Irish, and Depfa, the subsidiary of the soon-to-be-nationalized HRE, all have significant Irish covered bond exposure as well. So, this may be a way of getting at the Irish and Spanish markets, which are the two Euro land markets with the most significant property crashes. Pimco has a good primer on covered bonds on their site (click here) and I have written on this topic twice last summer (here and here).
However you look at it, the ECB has moved fully into ease mode along with the BoJ, the Fed, the SNB, and the BoE. This will be very supportive to the economy and the market. As always, don’t underestimate the power of printing money.
Below is a CNBC video detailing the interest rates and the covered bond move with a quote from ECB President Trichet himself.