As we noted previously, it is likely that whatever Draghi does this week "will not deliver a significant impulse to the real economy" in Europe but while negative rates are almost guaranteed (based on the consensus), reviving the ABS market (via focused QE) is being heralded by many as a positive swing factor. Unfortunately, as SocGen explains, even if the ECB began purchasing ABS in H2 2014, the size and reach of the market is not enough to move the scale as Europe acts desperately to avoid a Japanese-style lost decade.
ABS for dummies or what the ECB could do...
ECB to act to help peripheral SMEs
“What we need to be particularly watchful for at the moment is the potential for a negative spiral to take hold between low inflation, falling inflation expectations and credit, in particular in stressed countries” warned ECB president last week. Real rates remain too high compared to GDP in peripheral countries and the strength of the euro is reinforcing disinflationary pressures.
With ongoing concern on SME financing in the periphery, we expect the ECB to take unconventional measures at the 5 June meeting to boost SME lending. Action could take the form of a targeted LTRO (similar to the Bank of England’s Funding for Lending cheme) and/or an ABS* repurchase programme. *ABS: A financial instrument collateralised by one or more types of assets, including real estate, mortgages, receivables etc.
Reviving the ABS market
ABS issuance has been subdued in recent years for economic reasons (weak demand) but also due to technical obstacles, (including the deemed unfavourable regulatory treatment applicable to the ABS market).
For now, we expect that the ECB could start purchasing ABS in H2 14 (either in the market or directly from banks) to revive the ABS market. As the size of the ABS market linked to SME loans is small (c. €120bn in Europe) any asset purchase programme is likely to include other types of ABS to have more impact on the economy. But, according to SG ABS & Covered bonds analysts, ECB-eligible ABS outstandings amount to just €760bn (Q1 14). Therefore purchases could be further extended to other assets, such as supranational agency bonds, or corporate paper.
ECB is acting to avoid a Japanese-style lost decade
Successful reform of the ABS market could help improve credit conditions in the periphery and break the vicious circle between banks and sovereigns. Initiatives from different European institutions are under investigation (the EIB, the European Commission, the ECB, etc.) but reforming the securitisation market will take several years. Banking Union will also help reduce fragmentation in the future. But, for now, deflation risks are increasing, and the ECB could well fall ‘behind the curve’ if it does not take sufficient action. Any significant downward revision of inflation expectations would require a broader based QE programme (over €1 trillion in asset purchases, including sovereign assets).
The goal is clearly to avoid a Japanese style lost decade... because QE worked out so well for Japan?!