Published on 31 October 2017

The ECB’s version of Quantitative Easing – called “Asset Purchase Programmes” or “APP” – had been running at €60 billion a month and over a prolonged period, until the ECB announced last week that it was reducing new APP to €30 billion a month.

The market’s knee-jerk reaction was that this meant a tapering-off of the support as a recognition of the Eurozone’s economic strength. That is, until the other parts of the announcent were digested.

Firstly the programme is extended from March 2018 to September 2018.

Secondly funds from APP investments that mature will be reinvested.

The second point may mean that the purchases will now exceed €60 billion a month rather than be reduced.

If the current balance is around €2 trillion and the average life is 5 years, this means that €33 billion would mature each month, bringing the purchases back to and above their current level.

The cash side of APP is settled through the TARGET2 system, the data on which gives an indication of the total size of the assets purchased, and the net result: capital flight of around €3 trillion in total out of the Eurozone periphery and into Germany, Luxembourg, Netherlands and Finland – who then lend money back through TARGET2 to the Eurozone periphery to enable their central banks to complete the APP trades (€2 trillion), and to fund the other instances of capital flight (€1 trillion).

APP amounts to over 19% of Eurozone GDP and is a clear stimulus, though transmitted less directly than the European Investment Bank’s lend-and-spend spree, where 89% of its new loans are being made into the Eurozone, even though the Eurozone is only 70% of the EU economy.

The EIB stimulus directly adds 0.46% per annum to Eurozone GDP, so if you back that out of Eurozone GDP growth, and then back out the transmitted effect of APP as well, you have an underlying GDP picture that completely reflects the ECB’s concerns about inflation: it is too low, and because underlying growth is still very poor.

And it is not just for this reason that the ECB cannot raise interest rates. No indication is given in the ECB’s accounts of the marked-to-market value of the APP portfolio. This is a concern. The bonds are held at the Eurozone national central banks but at the ECB’s risk. Profits/losses are only passed up to the ECB when they are realised, via an APP transaction being unwound and the bond sold, or when a bond matures.

If rates begin to rise and for whatever reason, and if there is not already a substantial unrealized capital gain, even a small rise in yields creates a loss on revaluation exceeding the ECB’s capital and reserves.

In fact, a 10 basis point rise in yields would be sufficient to wipe out the ECB’s first line of defences, the size of movement that can happen within the course of a trading day.

That is why, like King Lear, the ECB is bound upon a wheel of fire and forced to continue APP without reduction.

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