Debt, debt, everywhere – and not enough bonds to buy. That’s the dilemma President Mario Draghi must resolve before he decides whether to extend the European Central Bank’s asset purchases beyond March 2017. It’s a minor test compared with the much bigger challenge of pushing up inflation.
The ECB made a rod for its own back when devising rules for the scheme that has seen it hoover up assets worth more than 1 trillion euros since its 2015 launch. The central bank cannot buy bonds that yield less than the deposit rate, currently -0.4 percent, and cannot own more than a certain proportion of each bond issue. Then there’s the so-called capital key rule, which requires purchases to be roughly proportionate to the size of euro zone members’ economies.
The guidelines were designed to reassure private investors and those who worry that asset purchases blur the lines between monetary and fiscal policy. But the ECB has been a victim of its own success. More than half of 2- to 30-year German sovereign debt now yields less than the deposit rate, according to Pictet analysts. That makes it hard for the ECB to hit its target of spending an average of 80 billion euros a month on assets – the majority of which are government bonds.
Draghi could scrap the capital key, but that would be anathema to Germany. So would buying bonds in proportion to the amount of outstanding debt, since this risks rewarding profligate countries. Cutting the deposit rate further would pose risks to the financial sector and just push bond yields down to this limit again. Broaden the range of eligible assets to include exchange-traded equity funds – following the Bank of Japan – or unsecured bank debt would also be controversial.
Draghi’s least-worst option may therefore be to say the ECB will tolerate some deviation from the proportions dictated by the capital key, with a view to redressing the balance eventually. Pragmatism would buy the central bank some time to focus on a thornier problem: the fact that euro zone consumer prices are barely rising. In time, inflation will either pick up, or have been worryingly low for long enough to render once-unpalatable ideas acceptable.