ECB may be prepared to react if necessary - BBH

Research Team at BBH, notes that the ECB meets later this month and the record from its June meeting will be published this week. 

Key Quotes

“The discussion of the UK referendum may be of interest; otherwise, the uninspiring meeting will likely generate an unremarkable record.  The ECB is in an implementation and monitoring mode.  It may be prepared to react if necessary, but it is not nearly ready for new initiatives. 

Market concern about a shortage of securities given the ECB's purchases has become more acute since the UK referendum.  German bonds with maturities out seven years yield less than minus 40 bp.   Would anyone be surprised if the 10-year Bund, now yielding minus 12.5 bp heads toward the deposit rate?

Spurred by a report last week citing "unnamed sources", there was speculation that the ECB was considering shifting its bond buying from the capital key (share capital provided to ECB, essentially GDP) to size of debt market.  We are suspicious of the story, and suspect "false flag" tactics, not by investors seeking an edge, but by partisans in a political fight, maybe meant to embarrass the ECB and cajole into denying.  A denial could weigh on peripheral bonds, especially Italy bonds, which would be a beneficiary of such a change. 

The ECB has a number of options that would likely prove less contentious than using the size of the sovereign debt market to direct the ECB's purchases.  The ECB could lift some of its self-imposed restrictions.  For example, it could waive the prohibition against buying bonds with yields less the deposit rate, or cap such purchases as a certain percentage of overall purchases. 

The ECB could increase the assets being purchased, such as bank bonds, which it has been seemingly reluctant to include.  Officials gave priority to agency and corporate bonds, but circumstances may force their hand, especially if the program is extended, beyond the current soft end point of March 2017.”