EUR: ECB QE On Sovereign Bonds Our New Baseline

Focus of the day:

"We now expect the ECB to extend its new asset purchase programme (ABS+covered bonds) by adding central government bonds (EGBs), most likely by Q1 2015. The change in our baseline is largely driven by two factors.

First, increasing the ECB’s balance sheet by up to €1trn to its 2012 size is unlikely to be achieved via TLTROs, ABS and covered bond purchases alone. TLTROs are likely to boost the ECB balance by c.€170bn this year, while ABS and covered bonds are likely to add less than €100bn in the coming quarters, on our estimates. Thus, EGB purchases will be needed to reach the ECB’s c.€1trn target.

Second, we believe that the risk of too long a period of low inflation is higher than the ECB’s inflation projections imply, while the growth outlook has significantly deteriorated and remains subject mainly to downside risks, especially for France and Italy.

...EGB purchases by the ECB remain a close call and we acknowledge a number of factors that could prevent the ECB from taking this controversial step, not least German opposition and moral hazard concerns – ie, EGB purchases could delay or discourage much-needed reforms. Among these factors, political/geopolitical risks could fade, boosting business sentiment and inflation expectations..."

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