As of 2 January, it has been possible for the ECB to undertake QE purchases below the level of the deposit rate 'to the extent needed '. In this note, we estimate how much buying below depo will be required in German government bonds in order not to breach the 33% issue limit under different rate scenarios for 2017.
We estimate that 15% of the QE purchases in German government bonds will have to be below the deposit level in our base scenario, with unchanged yields on German bonds throughout 2017. If purchases 'below depo' are postponed as long as possible, ECB purchases could continue 'unchanged' until November before QE would be forced 'below depo' in German government bonds. Admittedly, these estimates are very sensitive to the rate level, the fraction of government bonds versus agency/regionals in QE purchases and to some extent, the historical purchases pattern on the German curve .
The estimate is in particular sensitive to the development in yields in the 1-6Y segment on the German curve. In a scenario where the yield on German bonds increases 25bp across the curve, the ECB could avoid 'buying below depo' in 2017 and wait until March 2018 before being 'forced' below depo (assuming QE at EUR60bn per month continues beyond December 2017). On the other hand, if yields decrease 25bp, the 'QE fraction below depo' would increase to 40% of 2017 QE, and buying below depo would be forced to commence in August.
There has been no guidance on how 'QE below depo' will be implemented - hence, whether buying will be proportional or skewed towards higher yielding (closer to depo).
These insights have interesting implications for a possible extension of QE into 2018. As QE holdings will have hit the issue limit, all QE purchases will have to be done below the 'depo level' aside from the 33% new issuance (equivalent to EUR30-40bn in purchases above depo). An alternative to substantial purchases 'below depo' could be a deviation from the capital key. In our view, this is still a likely scenario as we approach the end of the 'QE era', where in particular the periphery is likely to be in need of sustained support in order to avoid material spread widening.
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