Taking stock of the Eurosystem’s asset purchase programme after the end of net asset purchases

Prepared by Felix Hammermann, Kieran Leonard, Stefano Nardelli and Julian von Landesberger

Following the Governing Council’s decision in December 2018 to end net asset purchases under the Eurosystem’s asset purchase programme (APP), this article reviews the implementation and effects of the asset purchases. The APP has proved to be an adaptable and effective instrument to ease monetary and financial conditions, foster economic recovery, counteract disinflationary pressures and anchor inflation expectations, thereby supporting a sustained adjustment in the path of inflation towards price stability. The APP has been part of a package of policy measures together with negative interest rates on the deposit facility, forward guidance and targeted longer-term refinancing operations (TLTROs), jointly creating synergies that have enhanced the effectiveness of each of the package’s individual components. From an implementation viewpoint, the Eurosystem ensured that asset purchases were conducted smoothly and flexibly by striving for market neutrality and mitigating unintended side effects for market functioning.

Whereas net asset purchases have come to an end, principal payments from maturing securities purchased under the APP will continue to be reinvested as this, together with enhanced forward guidance, provides the monetary accommodation that the Governing Council judges to be required for the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.

1 Introduction

The APP is part of a package of policy measures that was initiated in mid-2014 to support the monetary policy transmission mechanism and provide the amount of policy accommodation needed to ensure price stability. The room for further interest rate cuts had become very limited after monetary conditions were eased in the wake of the financial and sovereign debt crises by cutting key interest rates and deploying unprecedented measures to support monetary policy transmission. The APP, in combination with negative interest rates on the deposit facility, forward guidance and TLTROs, has helped the ECB meet its price stability objective. The APP comprises the third covered bond purchase programme (CBPP3, launched on 20 October 2014), the asset-backed securities purchase programme (ABSPP, launched on 21 November 2014), the public sector purchase programme (PSPP, launched on 9 March 2015) and the corporate sector purchase programme (CSPP, launched on 8 June 2016). APP net asset purchases were conducted until the end of December 2018, involving a total amount of €2.6 trillion. A snapshot of the APP portfolio in December 2018 shows the PSPP contributing the largest share, accounting for 82% of the total net purchases, followed by the CBPP3 (10%), the CSPP (7%) and the ABSPP (1%). The size of the APP portfolio is currently being kept stable by reinvesting principal payments from maturing securities.

2 The monetary policy rationale for launching the APP

Following a double-dip recession in the wake of the financial and sovereign debt crises, the euro area experienced a prolonged period of deleveraging, an atypically shallow recovery and persistently weak inflation. Bank lending conditions started to deteriorate and loan volumes (in particular those involving non-financial corporations) to contract at the end of 2011. Persistent weakness in the underlying growth momentum perpetuated capacity underutilisation, as also visible in high levels of unemployment. Inflation rates exhibited a protracted downward trend: in the core components, this was due to the general economic weakness, while declines in energy and food prices influenced the headline readings. Euro area inflation was generally projected to remain weak and fall over time, as reflected in successive downward adjustments in macroeconomic projections by most international organisations and the ECB (see Chart 1). Euro area annual HICP inflation fell to -0.2% in December 2014, and Eurosystem staff macroeconomic projections entailed further substantive downward revisions of inflation forecasts, from 1.1% to 0.7% in 2015 and from 1.4% to 1.3% in 2016.

Persistently weak inflation in 2013-2014 contributed to a downtrend in inflation expectations and an increasing risk of those expectations becoming unmoored from the ECB’s price stability objective. Market-based measures of inflation expectations drifted to extraordinarily low levels. At the end of December 2014 the option-implied probability density function of euro area inflation indicated that markets assigned a probability of almost 50% to deflation and saw only a marginal probability of annual inflation reaching a level close to 2% or above (see Chart 9 below). These developments indicated risks that too prolonged a period of low inflation could become entrenched in inflation expectations, with adverse consequences for price stability.

To reverse the downtrend in inflation and forestall a disanchoring of inflation expectations, the APP was designed to expand and complement existing monetary policy measures. With the APP, announced in January 2015, the PSPP, an additional programme consisting of purchases of debt securities issued by public entities, was launched to complement the two ongoing asset purchase programmes, the CBPP3 and the ABSPP.

During the period 2015-2018 net asset purchases under the APP were the principal instrument of monetary policy and their size and duration were linked to achieving a sustained adjustment in the path of inflation towards price stability. In January 2015, following the APP announcement, net asset purchases were made the principal policy instrument and the Governing Council adopted a structured forward guidance. The first building block of this guidance pertained to the principal instrument itself and featured a combination of a time-dependent and state-dependent formulation. The time-dependent leg stated that the net asset purchases were intended to run at a certain monthly pace at least until a specific date (see Figure 1). The state-dependent leg established an explicit link to the price stability objective (“or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim”). As shown in Figure 1, following the first announcement in January 2015 the Governing Council extended the programme through a series of recalibrations, in which the minimum horizon for the monthly purchases was pushed back sequentially and the pace of purchases was adjusted as necessary to advance progress towards the sustained adjustment. The second building block of the forward guidance pertained to the period over which the Governing Council expected that it would not be appropriate to raise the key ECB interest rates. In March 2016 the length of that period was linked to the end of the net asset purchases.

The Governing Council adopted APP modalities in accordance with the primary objective of price stability. APP design features were geared to provide the degree of policy accommodation necessary to deliver on the price stability mandate when it was hardly possible to lower key interest rates any further. In line with the prohibition on monetary financing laid down in Article 123 of the Treaty on the Functioning of the European Union, purchases of public sector securities were limited to the secondary market.

The APP was designed to take into account both market structures and the institutional set-up of the euro area. Purchases of public debt instruments were guided by the ECB capital key, which specifies the share of the ECB’s capital attributable to each of the national central banks. At the same time, private sector programmes were based on the market capitalisation of the eligible bonds included in the purchases.

3 Implementation issues

Market neutrality

When implementing the APP, the Eurosystem aimed to ensure market neutrality in order to minimise the impact on relative prices within the eligible universe and unintended side effects on market functioning. For instance, while aimed at affecting bond prices, the APP purchases were conducted with a view to preserving the price discovery mechanism and limiting distortions in market liquidity. Key features designed to ensure market neutrality in APP implementation are detailed below.

Clear and observable monthly APP targets were defined, with seasonal patterns in market liquidity also being taken into account. The average monthly APP target set ex ante by the Governing Council was decomposed internally into monthly purchase guidance per programme. The programme operating in the most liquid market, the PSPP, acted as a buffer to ensure the precise fulfilment of the overall monthly purchase target. In addition, the Eurosystem took into account seasonal patterns in fixed income market activity, such as the decline in market liquidity from mid-July to late August and in December. Purchase activity was front and back-loaded around these periods (see Chart 2). In all months, the purchase guidance was expressed in monthly totals, rather than strict daily volumes, providing flexibility in the day-to-day execution of purchases.

Comprehensive ex ante communication on the operational parameters of the APP supported the price discovery mechanism. The parameters defined the operational scope of the APP through (i) stringent eligibility criteria aligned with the procedures in place for the Eurosystem collateral framework^[1] and using the expertise of Eurosystem collateral management experts, (ii) maturity restrictions,^[2] (iii) the exclusion of certain issuers,^[3] (iv) pricing frameworks to ensure that purchases were conducted taking into account available market prices, and (v) different limit systems.^[4]

The Eurosystem took a rule-based approach to the composition of purchases with a view to maintaining adequate diversification across issuers and counterparties. APP purchases were broad-based across jurisdictions, maturity segments, issuers and types of eligible bond in terms of different coupon types or different collateral types, for instance. For the PSPP, the ECB’s capital key provided a straightforward, stable guideline for the composition of purchases across jurisdictions.

The Eurosystem geared its monthly purchase allocation to align a jurisdiction’s share in the stock of PSPP purchases as closely as possible with the respective share of the ECB capital key by the end of the net asset purchase phase. Chart 3 illustrates the deviation of the share of cumulative net purchases at the end of 2018 relative to the ECB capital key for each jurisdiction. For instance, the Eurosystem’s stock of German securities at the end of 2018 was 4.5% above the German share of the ECB capital key. This surplus equates to €22.3 billion.

A relative share of the PSPP stock above the ECB capital key in a jurisdiction resulted mechanically from the need to offset downward deviations in other jurisdictions. These downward deviations arose for two reasons. First, Greek government bonds were ineligible for the PSPP over the entire net asset purchase phase. Second, limitations were experienced in the availability of bonds for purchase, which arose, for instance, as bonds were held by hold-to-maturity investors or because of the overall size of the eligible universe in some jurisdictions.

APP purchases were executed regularly, while some flexibility was maintained to adapt to prevailing market conditions (see Box 1). The Eurosystem aimed to maintain a continuous market presence throughout the day, thereby avoiding temporary market dominance. Depending on a central bank’s operational modalities, flexibility can relate inter alia to the selection of securities to purchase, the timing of operations and the overall purchase amount for the day. Moreover, spreading purchases flexibly across the different asset classes included in a programme also helped to preserve market neutrality. As an example of this flexibility, the share of regional government purchases as a proportion of total PSPP purchases fluctuated significantly in 2018 (see Chart 4).

Fixed income market liquidity and its interaction with APP implementation

The APP purchases were executed in a way that aimed to safeguard the liquidity of euro area fixed income markets. Eurosystem staff regularly assessed bond market liquidity indicators. Taken together with market intelligence, these assessments indicate that the design of the APP has been successful in mitigating potential detrimental effects on market functioning and that the impact of the APP on market liquidity has been at most transitory.^[8]

Daily purchase modalities, and in particular the day-to-day selection of securities to be purchased, were applied with a view to preserving market liquidity conditions. The Eurosystem actively incorporated the offers from a broad range of counterparties in the daily bond selection. In addition, significant efforts were undertaken to avoid buying securities that were scarce, as measured by such metrics as relative value indicators, pricing in the repo market and trading volumes.

The size of individual transactions was responsive to the observed offer sizes. For APP transactions, the average secondary market transaction ranged from €4 million in the CSPP to €14 million in the PSPP. These averages mask compositional heterogeneity, with transaction sizes increasing for more liquid securities and declining for illiquid bonds.

Using a broad set of counterparties facilitated the smooth implementation of purchases and fostered competition, with the Eurosystem trading with more than 350 counterparties. A very large majority of APP purchases involve counterparties located in a different country from the purchasing central bank, which also impacted the distribution of Target 2 balances across jurisdictions.^[9] Individual central banks expanded their set of counterparties in order to reach all relevant segments of the fixed income market. APP implementation thus avoided persistent effects in the micro-structure of bond market segments through the competitive use of counterparties. Against this background, the Eurosystem adopted a wide range of transparency tools to minimise the informational advantages for eligible counterparties. These initiatives helped to level the playing field among financial market participants while preserving the timely execution of operations (see Box 2).

Securities lending

APP securities lending facilities addressed challenging repo market conditions. Combined with the gradual expansion of PSPP holdings, increasing demand for high quality liquid assets in line with regulatory requirements contributed to challenging repo market conditions through 2016. The Eurosystem purchases reduced the effective availability of securities for market participants, which could have resulted in a shortage of bonds to be used as collateral^[11] and lower market liquidity, while possibly impairing the price discovery mechanism. The Eurosystem’s securities lending approach served to minimise such unintended consequences of the APP.^[12]

The Eurosystem conducts securities lending activities, which continue in the reinvestment phase of the APP, in a decentralised manner on the basis of common principles. The Eurosystem acts as a backstop without curtailing normal repo market activity.^[13] The institutional set-up of the Eurosystem means that securities lending implementation is decentralised and various lending channels are used (e.g. bilateral lending or through custodians). As illustrated in the upper panel of Chart 5, the share of German government bonds trading “special” – that is trading at a premium to general collateral in the repo market – increased markedly in 2016. The Eurosystem responded by introducing a number of modifications to the securities lending facilities, such as the option to borrow bonds against cash collateral. This was introduced in December 2016, effectively increasing the supply of bonds available in the repo market and reducing the share of bonds trading special.^[14] Several other beneficiary owners also enhanced their securities lending facilities during this period.

The PSPP on-loan balance fluctuated, with peaks occurring at quarter-ends and ahead of futures delivery dates. At the end of 2017, the market value of bonds lent out peaked at €87 billion, €33 billion of which was lent against cash collateral (see Chart 6, right panel). The average monthly on-loan balance however stabilised between €50 billion and €60 billion since mid-2018, representing 2.4-2.8% of the respective monthly PSPP holdings (see Chart 6, left panel).

4 Transmission and impact on the macroeconomy

Main transmission channels

The APP has provided a substantial improvement in financing conditions via several transmission channels, and each individual policy measure, being part of a package of policy measures, has benefitted from reinforcing synergies. Evidence based on event studies shows that yields fell significantly across all financial market segments following the APP announcement.^[15] Over the course of APP implementation, declining bank lending rates and credit expansion helped to ease financing conditions, support a firming of the economic recovery and counter disinflationary forces. As documented by a large body of literature, the APP operates through three main channels: the signalling channel, the portfolio rebalancing channel and the direct pass-through channel.^[16] The package of policy measures of which the APP was part has created mutually reinforcing synergies across the individual measures.

Via the signalling channel, the APP has underscored the ECB’s intention to provide sufficient monetary stimulus for an extended period of time, thereby also contributing to anchor policy rate expectations. The APP has enhanced the signal that key policy rates would remain low for long. The signalling aspect of central banks’ large-scale asset purchases has always been found to be an important component of transmission for such policy programmes. This component was reinforced in March 2016, when the Governing Council’s communication of the expected future rate path was made conditional on the end of net asset purchases.

Via the portfolio rebalancing channel, the APP has compressed yields across a wide range of asset classes, with negative rates on reserves providing additional incentives to the rebalancing process. With the price of the purchased assets being bid up, their yields decrease. The lower yields induce investors to sell these securities, earning the associated capital gain. As sellers may not view holding the liquidity received as being a perfect substitute for the assets sold, they reinvest and rebalance their portfolios towards other assets, such as securities and loans (see also Box 4). This process is reinforced by the negative rates charged on reserves.^[17] Consequently, yields also decreased in other market segments not targeted by the central bank purchases, including a rebalancing in non-euro denominated debt and equity markets.^[18]

Within the portfolio rebalancing channel, the extraction of duration risk has been a particularly relevant mechanism affecting the term premium component of medium and long-term yields (Box 3). Asset purchases decrease the duration risk borne by private investors, thus increasing their risk-bearing capacity and incentivising them to restore the desired overall risk profile of their portfolio by investing in different assets. Therefore, duration extraction affects the pricing of maturities and asset classes beyond securities purchased.

Via the direct pass-through channel, which comes into play for the ABSPP and the CBPP3 in particular, the APP has directly improved credit conditions for the private non-financial sector. At the same time, the CBPP3 and TLTROs have interacted to foster lending to small and medium-size enterprises (SMEs) as well.^[19] More generally, TLTROs have alleviated the funding costs for participant banks, thus mitigating possible negative effects on bank lending stemming from negative rates on reserves. Central bank purchases have raised the price of ABS and covered bonds, lowered the market interest rate paid by the originators and encouraged banks to create more loans with a view to repackaging them and selling them on. Through this mechanism, bond purchases have supported borrowing conditions in the private non-financial sector. Similarly, the CSPP has reduced funding costs for firms accessing financial markets directly and supported a switch from bank funding to market funding for large firms, thereby freeing up capacity on bank balance sheets to finance loans to SMEs.^[20]

The APP has eased financing conditions across asset classes. Liquidity injected by the APP has tied up short-term money market interest rates at levels close to the ECB’s deposit facility rate and, together with negative rates and forward guidance, anchored the expected path of money market rates in line with the intended policy stance. Chart 7 shows the estimated accumulated easing impact of the APP across asset classes – alongside that from other easing measures – relative to actual asset price changes recorded since 2014.^[25] The APP is estimated to have decreased sovereign yields and pushed down yields of bonds issued by non-financial corporations (NFCs), and to have contributed to an increase in share prices.

Banks have played a crucial role in the transmission of net asset purchases to financing conditions. Bank-based financial intermediation remains very important, notwithstanding a trend towards market funding in the financing structure of euro area NFCs over the last decade. The APP, acting in conjunction with negative interest rates on the deposit facility and TLTROs, has incentivised banks to reinvest the proceeds from asset sales into loan creation (see Box 4).

As a result, bank lending rates have steadily declined and converged across euro area countries since mid-2014. Composite lending rates to NFCs currently stand close to record lows (see Chart 8, left panel). Model-based results indicate that the APP and DFR cuts have led to a reduction of around 50 basis points in bank lending rates to NFCs since June 2014 due to their impact on the yield curve.^[26] Previously large dispersions in borrowing costs across euro area countries have progressively narrowed to the point of being almost fully reabsorbed.

The APP is also found to have contributed significantly to the recovery in loan growth. NFC loan volumes started growing again with positive rates in mid-2015. Model-based simulations suggest that almost half of the annual growth in NFC loan volumes in the third quarter of 2018 (4.3%, see Chart 8, right panel) can be attributed to the effects of the APP.^[27] Box 4 provides further details on the bank-based transmission of the APP to lending.

Impact on the euro area economy and inflation, and progress towards a sustained adjustment in the path of inflation

The APP, in conjunction with the other monetary policy measures, has provided a substantial contribution to the economic recovery and the formation of inflation expectations. According to calculations by Eurosystem staff, the overall impact of the policy measures adopted since mid-2014 on the euro area inflation rate is estimated to be around 1.9 percentage points cumulatively between 2016 and 2020, with the strongest impact being felt in 2016 and 2017 (see Table 1). The impact on real GDP growth is of a similar size.

In June 2018 the Governing Council signalled that it expected to end the net purchases by the end of the year, and in December 2018 the decision to terminate the net purchases was confirmed. The decisions taken by the Governing Council at different stages of the asset purchase programme to extend, expand, scale back and finally end net asset purchases have consistently been informed by its assessment of the progress made towards achieving a sustained adjustment in the path of inflation. Upon a review of the progress made, in June 2018 the Governing Council signalled its anticipation that, subject to incoming data confirming the Governing Council’s medium-term inflation outlook, net asset purchases would end in December 2018. The end of net asset purchases was indeed confirmed in December 2018.

The assessment that the progress was substantial was based on a comprehensive review that took into account, among other elements, Eurosystem staff macroeconomic projections, measures of price and wage pressure, and uncertainties surrounding the inflation outlook. The Governing Council’s positive assessment of the progress towards a sustained adjustment of inflation that was carried out in June and December 2018 was underpinned by the stronger anchoring of longer-term inflation expectations, the underlying strength of domestic demand and the continuing ample degree of monetary accommodation, which provided grounds for confidence that sustained convergence would continue and be maintained even after the end of net asset purchases.

Over the course of 2018, the medium-term projections for headline inflation had moved closer to 2% (see Chart 1). Furthermore, uncertainty surrounding the inflation outlook had receded significantly, with the risk of deflation virtually vanishing. Inflation expectations as measured using different sources had been gradually improving, and had moved to levels closer to the ECB’s inflation aim. The predictive distribution derived from model-based assessments, market-based measures of inflation compensation (see Chart 9), and survey-based measures of inflation expectations had shown that substantial progress had been achieved. Moreover, while measures of underlying inflation remained generally muted, labour cost pressures had continued to strengthen amid high levels of capacity utilisation and tightening labour markets, thereby providing additional supporting evidence that the return of headline inflation towards the ECB’s target was sustainable.

Finally, the path of future inflation was judged to have become more resilient over time, making it less reliant on net asset purchases. Consistent with the propagation patterns that are characteristic for standard and non-standard policy interventions, the estimated profile of the impact of net additions to the APP portfolio had a tendency to diminish progressively over time. Based on this evidence, current and future inflation developments could be assessed to be less reliant on net asset purchases.

5 Outlook

The Governing Council’s decision in December 2018 to end net asset purchases was accompanied by the decision to continue reinvesting the principal payments from maturing securities purchased under the APP and to enhance its forward guidance on policy rates and reinvestment. In December 2018 the Governing Council completed the rotation from net asset purchases to policy rates as the new principal policy instrument. As regards the first building block of its forward guidance, and similarly to the structure adopted during the period of net asset purchases, the rate guidance provided by the Governing Council since December 2018 features a time-dependent leg (i.e. key ECB interest rates are expected to “remain at their present levels at least through the summer of 2019”) and a state-dependent leg linking the evolution of policy rates to the price stability objective (“and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term”). The second building block of the guidance links the reinvestment horizon directly to the principal policy instrument in a chained manner. Accordingly, the Governing Council currently states its intention to continue reinvesting, in full, the principal payments from maturing securities purchased under the APP for an extended period of time past the date when key ECB interest rates would be raised, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.

During the reinvestment phase, the Eurosystem will continue to adhere to the principle of market neutrality built around smooth and flexible implementation. To this end, the principal redemptions will be reinvested with a view to allow for a regular and balanced market presence. In 2019, APP redemptions will amount to EUR 203 billion, implying average monthly reinvestments of nearly EUR 17 billion. Limited temporary deviations in the overall size and composition of the APP may occur during the reinvestment phase for operational reasons. Any adjustment to the portfolio allocation across jurisdictions will be gradual and calibrated as appropriate to safeguard orderly market conditions.

Overall, the APP has helped the ECB fulfil its price stability mandate, making it an effective instrument in the central bank’s policy toolkit. Alongside other policy measures taken since mid-2014, the APP has proved to be an adaptable and effective monetary policy instrument, helping the ECB to carry out its mandate.