March 6, 2019 / 11:15 AM / a year ago

Breakingviews - ECB stimulus flows show why Draghi works so hard

ECB headquarters in Frankfurt, Germany.

LONDON (Reuters Breakingviews) - The course of central banking rarely runs smoothly these days. Take the roughly 2 trillion euros of government debt that the European Central Bank bought to help the euro zone economy. While the plan worked, new analysis shows some of the liquidity flowed in surprising ways that diluted its effectiveness.

The ECB bond buying, which began in March 2015 and ended in December 2018, was designed to push investors into higher-risk debt and push down borrowing costs in the euro zone. That generally happened. But so did a couple of other things.

Non-euro zone investors, who accounted for approximately half of net sales to the ECB, parked some of the money they got from the central bank on deposit, according to a Bank for International Settlements paper published on Tuesday. Between the end of 2014 and the end of 2017, euro-denominated deposits outside the single currency area rose by approximately 190 billion euros, or almost 20 percent of the total volume of public sector securities sold to the ECB by non-euro zone investors, the BIS paper found.

Moreover, foreign borrowers soaked up some of the money. The share of euro-denominated securities held by major non-euro zone investor countries, like Japan, stayed relatively stable, even though their portfolio managers had sold bonds to the ECB. One reason is that companies outside the euro zone rushed to take advantage of relatively cheap funding rates and issued debt in euros. 

That’s not to say the money printed was wasted. Funds placed on deposit, for example, would have eventually flowed back into the euro zone and used to extend credit, if there was sufficient demand. But the fact that investors did not automatically re-allocate the funds from bond purchases to riskier euro zone issuers, suggests that portfolio rebalancing effects, one of the key purposes of bond-buying, cannot be taken for granted. And if the ECB is trying to push liquidity through the financial system as quickly as possible, such convoluted diversions make its policies less immediately effective.

The challenge may be more acute for the ECB than say, for the Bank of Japan, since the euro zone’s deeper and more liquid capital markets attract more overseas issuers, increasing scope for substitution into overseas securities. Still, as the BIS paper shows, money printing is an imprecise tool that works in unexpected ways.


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