ECB has room for manoeuvre to prevent an increase in corporate bond yields

Macro Highlights - 11/13/2017

In short
  • ECB has room for manoeuvre to prevent an increase in corporate bond yields
  • Emerging focus: Growth set to stabilise in 2018

Key Takeaways of the week with Sophie Casanova, Economist, Central Banks and François Léonet, Economist, Emerging Markets
  • While the European Central Bank will halve the net amount of its monthly asset purchases to EUR 30 billion from January 2018…
  • …its gross purchases will remain at a high level because it will need to reinvest nearly EUR 100 billion that will be received when the securities it holds reach maturity, between January and September 2018
  • According to our analysis, the share of corporate bonds within the total amount of these gross purchases could be increased, enabling the ECB to prevent a rise in credit spreads

In line with the commitment made at its meeting on 26 October, the European Central Bank has published, for the first time this week, the amounts that it will be reinvesting over the next 12 months when the securities it holds as part of its quantitative easing programme mature.

This information is important since the flow of redemptions of securities held by the ECB, which was relatively low up until now because the asset purchase programme began in March 2015, will become significant from 2018. While the ECB is getting ready to scale back its new securities purchases from EUR 60 billion to EUR 30 billion per month from January 2018, if we take these reinvestments into account, its gross purchases of securities will continue to be high.

The data released by the ECB shows that between November 2017 and October 2018, the total amount of reinvestments will represent EUR 130 billion, with a monthly average of EUR 10.8 billion. From January 2018 to September 2018,
EUR 100.8 billion will be reinvested, with an average of EUR 11.2 billion per month. This means that the ECB’s gross purchases over this period will average out at EUR 41.2 billion per month
. This gross amount is still high if we compare it for instance with the level applied between April 2017 (i.e. when the ECB reduced its monthly purchases from EUR 80 to 60 billion), and October 2017, which was EUR 65.6 billion per month.

A more detailed analysis shows that it is primarily the sovereign bonds held by the ECB that will be reaching maturity (EUR 78.1 billion between January and September 2018) and that the amount of private securities (corporate bonds, ABS and covered bonds) will be lower (EUR 22.7 billion).

However, the ECB has never made any commitment, since its asset purchase programme was launched, to respect any specific breakdown between its purchases of sovereign bonds and private bonds. During its meeting on 26 October, it also highlighted that, despite reducing its programme’s monthly figure, its purchases of private sector securities will continue to be “sizeable”.

 According to our analysis, this means that the ECB could increase slightly from January 2018 its percentage of private bond purchases, particularly corporate bonds, in relation to the total gross amount of its securities purchases.

This change in the structure for the ECB’s securities purchases could have the following implications:

  • The upward pressures on corporate bond yields should be limited in 2018 despite the ECB scaling back its monthly securities purchases.
  • Credit spreads, i.e. the difference between yields on corporate and sovereign bonds, are expected to remain low.
  • The companies that are likely to benefit most from the ECB’s purchases will continue to be from sectors with the highest levels of bond debt. This reflects the guidelines for the ECB’s purchases, which are prorated based on the outstanding amount of existing bonds per sector and per country.
  • Our forecast for a continued moderate steepening of sovereign yield curves in 2018 is expected to be supported by this change in the structure of the ECB’s purchases.

Sophie Casanova, Economist, Central Banks


Emerging focus: Growth set to stabilise in 2018

  • Following an acceleration that we expect to reach 4.9% in 2017, growth for the emerging market bloc looks set to stabilise at 5.0% in 2018
  • We expect emerging investment to remain moderate in 2018, linked in particular to the deceleration in growth and the continued real estate slowdown that we expect to take place in China
  • The persistent output gaps in the main emerging economies should limit the upside pressures on the region’s inflation in 2018

The acceleration in real GDP growth for emerging economies since 2016 reflects several factors. Alongside the upturn in economic activity in China at the end of 2016, as well as in the first half of 2017, this acceleration has been driven primarily by the upturn in growth for commodity-exporting emerging countries. According to our estimates, nearly 75% of the emerging acceleration over the past 12 months has been attributable to these countries. Illustrating this, the Russian and Brazilian economies have returned to positive year-on-year growth, bringing an end to a long recession phase lasting several quarters (see left-hand chart). According to our analysis, after accelerating in 2017, the emerging market bloc’s growth is expected to stabilise in 2018. It looks set to come in at 5.0% for 2018, compared with 4.1% in 2016 and 4.9% in 2017.

Linked in part to the commodities sector, the upturn in emerging exports has not been accompanied by any significant acceleration in industrial production or investment in these countries (see right-hand chart). The investment cycle continues to show mixed results for economies like Brazil or India, and is moderating in China. Emerging investment trends are expected to remain moderate over the coming quarters.

On the one hand, capacity utilisation rates in emerging economies are still below their pre-crisis levels, which does not indicate that corporate investment levels are likely to pick up significantly. Similarly, the credit relay is not expected to offer a significant support for investment either. This is seeing contrasting trends depending on the emerging region (see left-hand chart). In Brazil, the strong disinflation and accommodative monetary policy are expected to reinforce the slow recovery on the credit market, but the persistent political uncertainty could undermine the business climate and discourage companies from investing. In emerging Asia excluding China and India, following several years of accommodative monetary policies, the central banks are expected to gradually raise their key rates faced with growth that has now normalised and expectations for inflation to rise. Alongside this, levels of debt have increased over the last few years in this region. Lastly, in China, the credit market is not likely to accelerate, in line with the commitment outlined again by Xi Jinping for tighter control over financial risks and informal credit.

In addition, China’s real estate market looks set to continue cooling in 2018, impacted by the restrictive measures rolled out by certain cities (to prevent overheating risks), as well as less flexible mortgage conditions and a level of household debt which – although still moderate compared with other countries – has risen significantly in the past few years. These elements, combined with the expected drop in infrastructure investment in 2018, are likely to lead to a contraction in investment in fixed assets and import volumes in China, limiting the prospects for an acceleration in exports and investment for the emerging market bloc.

In terms of the various countries, we expect to see a moderation of growth for China over the next few years, with 6.4% forecast for 2018. Following the negative impacts on domestic activity with the demonetisation from end-2016 and the introduction of a unified VAT system, India is expected to see its growth pick up over the coming quarters, while Brazil looks set to continue with its slow convergence towards its potential growth in 2018, which we are estimating at 1.5-2%.

Emerging inflation is down to a historically low level, close to 3% (see right-hand chart). Inflationary pressures are expected to be limited by the persistent output gaps that have yet to be addressed in the major emerging economies. Emerging Asia excluding China and India seems to have overcome this output gap, which indicates that inflation could rise in this region. However, this is likely to remain moderate because we do not expect to see any significant acceleration for these economies in 2018. The drop in food prices since mid-2016 – on average these account for nearly one third of the basket for consumers in the main emerging economies – has contributed to the emerging disinflation. A normalisation of these food prices would push up local inflation. For 2018, we expect inflation to average out at 3.2% for the emerging market bloc, compared with 3.0% for 2017.

François Léonet, Economist, Emerging markets