Quantitative operations in EU

a look at tightening or easing activities by the ECB

is the ECB giving liquidity to markets?

Weekly Flows:

• the ECB is running quantitative tightening right now
• it has removed liquidity from bond markets for EUR -7.0bn last week, after adding EUR 15.4bn the week before
• it has removed liquidity frombond markets for a total of EUR -7.0bn last week, after removing EUR -22.4bn the week before

Balance sheet updates:

• the ECB has now EUR 3.6trn assets on the balance sheet - shrinking vs last week
• Quantitative tightening is very intense, removing substantial liquidity from bond markets on the current balance sheet size

IntroAs we already know from previous charts and comments, the ECB plays an incredibly important role in stabilizing the European economies and markets. The ECB’s main monetary policy tool to influence economic activity is through adjusting the short-term interest rate. But there are more tools available. The ECB in fact may also want to affect long-term rates, something that can be carried out by buying or selling government securities and other financial instruments in open markets.

DefinitionsBuying or selling government securities (and eventually other financial instruments) in open markets is known as quantitative easing (QE) or tightening (QT), and is typically implemented when other monetary policy actions need to be reinforced. QT refers to monetary policy operations that contract or reduce the ECB balance sheet (QT is also known as balance sheet normalization). QE refers instead to monetary policy operations that expand or increase the ECB balance sheet (QE is also known as balance sheet expansion) .

How do QE/QT work in practiceUnder QT, the ECB shrinks its monetary reserves by either selling European government bonds (spreading the sales country to country through specific ratios) or letting them mature and removing them from its cash balances. This removes liquidity from financial markets. Conversely, under QE, the ECB increases its monetary reserves by buying European government bonds (spreading the purchases country to country through specific ratios) and adding them to its cash balances. This injects liquidity into financial markets.

In summary, QE/QT operations reinforce other monetary policy tools by affecting interest rates across the yield curve of government bonds (including long-term rates) and ultimately impact borrowing costs for companies and the government ultimately influencing economic activity - growth and employment.

Chart guideWe can see in the chart both the accumulated stock of assets in the ECB balance sheet (shaded area) and the weekly new flows related to quantitative operations, either adding or removing assets from the ECB balance sheet (and liquidity from markets).

Net bond supply in EU after QE/QT

a look at the impact of ECB demand on bond supply

how many bonds are available after ECB interventions?

Bond demand & supply dynamics in EU:

• net bond supply keeps trending upward
• the full bond issuance continues to remain available to private investors, as the ECB is not demanding bonds: it runs quantitative tightening instead, withdrawing liquidity from markets

In summary and in light of the current ECB quantitative operations, European bond yields are not currently supported by monetary policy given the positive net bond supply available

IntroIssuing bonds is one way for companies and governments to raise money. Total bond issuance is the cumulative amount of bonds issued by all companies and governments in a period in a certain region and available for investors to buy.

Back to basics: what is a bondA bond works like a loan between an investor and a corporation, or government. The investor agrees to give the bond issuer a certain amount of money for a specific period of time. In exchange, the investor receives periodic interest payments. When the bond reaches its maturity date, the bond issuer repays the investor.

ECB and available bond supply in EuropeAs anticipated in the comments under the left chart, the ECB can run open market operations to add or remove liquidity from market via bond purchases. If the ECB runs quantitative easing, it acts as a major buyer of bonds on the market. Conversely, when it runs quantitative tightening it may either turn into a major seller of bonds held in its balance sheet or just not participate into new issuance.

Those quantitative operations affect net bond supply (i.e. the amount of bonds available to buy after issuance, net of ECB purchases or sales) and can subsequently drive bond yields and bond prices.

Chart guideWe show three things in the chart above: (1) total monthly bond issuance (in grey) in Europe, (2) inverted ECB flows (in turquoise) where negative bars represent ECB purchases (QE) while positive bars represent ECB withdrawals (QT), (3) the difference between bond issuance and ECB flows is shown via the yellow line, representing the net debt available

Key market implicationsIf the yellow line is above zero, available bond supply is higher than ECB current demand. This means that bond supply is left entirely to private investors: if they buy all issuance, bond yields are likely to compress on average; if not, they are likely to widen, same things equal. Conversely, if the yellow line is below zero, driven by price-insensitive ECB demand, bond yields are likely to compress (price higher), same things equal.